How Reverse 1031 Exchanges Work

Business and real estate leaders will often leverage the 1031 exchange process to reinvest their profits in new properties without paying capital gains taxes. A standard 1031 exchange is relatively straightforward:  

1. Sell your commercial property.
2. Instead of paying taxes on the gains from the sale, engage in a 1031 exchange process.
3. A qualified intermediary (title company) holds your profit in an escrow account until you find another building to buy.
4. Buy a new property within six months of the previous sale, using the profits that have been sheltered from taxes.

A 1031 exchange presents tax benefits. It is also a brilliant opportunity to expand an investment portfolio over time. 

How Is a Reverse 1031 Exchange Different?

If you find a replacement property before selling your current property, you might want to consider a reverse 1031. However, this is a more complex process than a regular 1031 exchange and presents challenges that must be navigated carefully.

First, a reverse exchange requires you to find an Exchange Accommodation Titleholder (an “EAT”) to hold title to either your current property or your new replacement property until the completion of the exchange. The EAT is a single-member limited liability company (SMLLC) created by your qualified intermediary with the sole purpose of temporarily holding the title, or “parking” the property until the previous property sells. 

Second, the IRS has regulations that prohibit an Exchanger from using exchange funds to improve the property that the Exchanger already owns. If that is something that you want to do, you must enter into an Improvement or Build-to-Suit Exchange.

What Are the Time Restrictions?

It’s important to follow two strict deadlines when conducting a reverse 1031 exchange. Failure to meet both the 45-day and 180-day deadlines will mean you are not shielded from paying capital gains taxes.

• Day 45 Deadline: On or before midnight on the 45^th day after the EAT acquires the temporarily held or “parked” property, the Exchanger must explicitly identify in writing the potential resigned properties for the exchange.
• Day 180 Deadline: On or before the 180^th day after the EAT acquires the “parked property,” the EAT must transfer either a parked replacement property to the Exchanger, or a parked relinquished property to a third-party buyer.
  

The Bottom Line

Both a 1031 exchange and a reverse 1031 exchange are great opportunities to expand your portfolio and continue your real estate growth, but they do have nuances and specific processes to follow. If you would like help executing such a transaction, National 1031 would be happy to assist you.

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Don’t trip up in the complexities of a 1031 exchange. National 1031 is your expert in guiding you through a 1031 exchange and serving as your Qualified Intermediary.

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