What's a Reverse 1031 Tax Exchange?

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A Reverse 1031 Exchange is a variation of the standard 1031 exchange that allows an investor to acquire the replacement property before selling the original property. This type of exchange can be particularly useful if the investor has already identified a desirable replacement property but hasn't yet sold their current property.

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In a standard 1031 exchange, the investor sells their current property first and then uses the proceeds to purchase the new property. In a reverse 1031 exchange, the order is flipped.

 

Here’s how it works:

 

Key Steps in a Reverse 1031 Exchange:

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1. Identification of the Replacement Property: The investor identifies and purchases a replacement property before selling the original property. This can be useful in situations where the replacement property is in high demand, and the investor wants to secure it quickly.

2. Use of a Qualified Intermediary (QI): Since the rules of a 1031 exchange require the taxpayer not to have direct access to the sale proceeds, the investor will work with a qualified intermediary (QI). As your QI, Commonwealth1031.com LLC will help facilitate the transaction and ensure that the exchange complies with the IRS regulations.

3. Holding the Replacement Property: To facilitate the exchange, a qualified intermediary or a third party (often a specially-formed LLC) will hold title to the replacement property for a short period (typically up to 180 days). This ensures that the replacement property is held by someone other than the taxpayer during the exchange.

4. Selling the Original Property: After the replacement property is purchased, the investor has up to 180 days from the purchase of the replacement property to sell the original property. The proceeds from the sale of the original property will then be used to pay back the financing or the intermediary.

5. Completion of the Exchange: Once the original property is sold, the exchange is completed, and the capital gains tax on the sale of the original property is deferred, just like in a standard 1031 exchange.

 

Benefits of a Reverse 1031 Exchange:

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• Secures a Property First: Investors can secure a desired replacement property before selling their original property, which can be especially beneficial in competitive markets.

• More Flexibility: It offers greater flexibility when the investor finds the right property but has not yet sold their current one.

 

Considerations:

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• Complexity: Reverse 1031 exchanges are more complex than regular 1031 exchanges and may require more detailed planning and documentation.

• Costs: There are additional costs associated with setting up and managing the exchange, such as fees for holding the property with a qualified intermediary.

• Strict Timeline: The 180-day timeline still applies for both selling the original property and completing the entire transaction, so it requires careful planning.

 

Key Differences from Standard 1031 Exchange:

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• Property Purchase First: In a reverse exchange, the replacement property is purchased before the original property is sold, whereas in a regular 1031 exchange, the sale of the original property happens first.

• Qualified Intermediary's Role: A reverse exchange often requires the use of a "reverse exchange accommodation titleholder" to temporarily hold the title to the replacement property.