What Is a Reverse 1031 Exchange?
A reverse 1031 exchange is a way that allows real estate investors to sell one investment property for another without incurring capital gains taxes. In a 1031 exchange, a taxpayer sells an investment property and buys a new property with its proceeds. But in a reverse 1031 exchange, the process is reversed. The investor first buys a new property and then has 180 days to sell their old property, which should be equal to or lesser value of the new property.
Reverse 1031 exchanges also occur with like-kind properties that the IRS recognizes as eligible for tax deferral. Real estate investors trading investment properties in a reverse 1031 exchange must use a qualified intermediary to transfer funds from the relinquished property to the new property. They also need to enroll an exchange accommodation titleholder (EAT) to hold the title of the replacement property for the exchange period. This agreement is known as a qualified exchange accommodation arrangement.
Requirements for a Reverse 1031 Exchange
Reverse 1031 exchange is similar to regular 1031 exchange but is only available to those trading investment properties. These investments do not include a primary residence but have rental properties, apartment buildings, vacation homes, and business properties. Apart from this, there are a few rules that the investor needs to follow before doing a 1031 exchange.
- Property value: The value of the new property must be equal to or more than the relinquished property. The sale proceeds of the abandoned property may be taxed if the new property’s weight exceeds its market value.
- Use of funds: The investor must use all the funds received after selling the relinquished property to buy the new exchange property.
- Property type: Both the relinquished and replacement properties must be considered like-kind properties. For example, residential properties can only be exchanged for other properties, making it a like-kind exchange.
- Timeline: The relinquished property has to be identified within 45 days of the purchase of the new property and must be sold within 180 days of the latest property purchase.
REVERSE 1031 EXCHANGE TIMELINE
The investor must complete the buying and selling process of both relinquished and replacement properties within the defined time frame set by the IRS. From the day the new property is bought, the investor has:
- Forty-five days to identify which property to give up.
- After that, the investor has another 135 days to sell the investment property.
- The whole transaction has 180 days to be completed from the purchase date of the replacement property.
During the 180 days, the property is held and protected under the IRS Revenue Procedure safeguard.
BENEFITS OF A REVERSE 1031 EXCHANGE
There are multiple benefits of using Reverse 1031 exchange few of which are explained below:
- The investor can buy a replacement property in a competitive marketplace when he wants and at his desired price.
- Suppose you are buying the property in cash. In that case, the investor can easily find the replacement property within 45 days, as we do in a traditional 1031 exchange.
- It provides time to consider which property to exchange for the replacement property investment.
- It provides time to negotiate contract terms, selling price, conditions, etc., with the buyer of the relinquished property.
Like a traditional 1031 exchange, it allows the investor to avoid paying capital gains taxes and other taxes.
While the reverse 1031 exchange process is more complex than other exchanges, investors can complete them. Like any significant investment decision, make sure you have a plan before opting for it. Utilize our expert resources throughout the exchange process to assist you, and keep doing your research to understand the exchange process better.