I often get questions from clients inquiring about reverse 1031 exchanges, asking what they are and how they work. Let's start with a refresher on a typical 1031 exchange. A typical exchange is accomplished when the exchanger sells a property and then acquires a new replacement property using the funds from the sale of the old property.
This is often called a forward or deferred 1031 exchange. Doing an exchange this way will result in deferral of capital gains and other taxes as long as certain procedural steps are followed.
A reverse 1031 exchange comes into play when an exchanger is planning to do an exchange, however, the purchase of the new property is ready to close and the old property is not yet sold.
Reverse exchanges provide the flexibility needed to make this work.
There are a couple main hurdles to get over to complete a reverse exchange. The first major hurdle is that the exchanger cannot own both properties at the same time. This means that the exchanger cannot acquire title to the new property until the old property has been sold, which is just the opposite of what an exchanger wants to do in a reverse scenario. So that begs the question how to do a reverse exchange to get over that hurdle? I like to say that every reverse exchange has a forward exchange within it and I tell exchange clients that they still need to sell their old property and then purchase their new one in that order. The way to make this work is to have an exchange accommodator acquire one of the properties and hold or "park" the title to that property during the exchange period. The accommodator is an exchange company and will typically hold title to the property that the client wants to buy. The accommodator will hold the title to that property until the client can sell the old property. Then the client will buy the new property from the accommodator. This process allows the client to sell their old property and acquire the new property in that order. The second major hurdle is financing this process. Since there are no funds from the sale of the old property to apply to purchase the new property, how does the purchase get accomplished? Financing for a reverse exchange can be accomplished with financing from an institutional lender such as a bank, from the client's own funds or a combination of both. Since there are no funds from the sale of the old property just yet, the exchanger must have access to funds to complete the closing of the new property. If a client can work out financing, a reverse exchange can be accomplished. Reverse exchanges do have some procedural issues to conquer, but are very beneficial in allowing a client to accomplish an exchange and avoid taxes in cases where the exchanger is ready to purchase a new property but has not yet sold their old property.
Here at Gain 1031 Exchange Company we have a holding company that facilitates reverse exchanges. Please contact us to find out more about the reverse exchange process to determine if it can work in your situation.
By Patrick T. Harrigan
Certified Exchange Specialist
Gain 1031 Exchange Company