Reverse 1031 exchanges were officially recognized with Revenue Procedure 2000-37, providing a safe harbor for the Exchange Accommodator Titleholder (EAT) to park either the relinquished (old) or replacement property for up to 180 calendar days. Prior to this milestone, 1031 exchanges were either forward or simultaneous exchanges where the old property is closed before the new property is acquired. Simultaneous 1031 exchanges are those where the old and new properties are exchanged at one closing. Reverses provided flexibility to acquire the new property before selling the old.
A 1031 exchange is a section in the Internal Revenue Code that enables both U.S. resident and non-resident individuals, trusts, partnerships and corporations to defer the capital gain or loss and recaptured depreciation taxes when real or personal property held in the productive use of a trade, business or for investment is exchanged for property held in the productive use of a trade, business or for investment. The strategy is different from a sale given the taxpayer must engage a Qualified Intermediary prior to the exchange to prepare 1031 exchange documentation and an escrow account to hold the exchange proceeds. The Qualified Intermediary cannot be a disqualified party (sibling, spouse, lineal or descending, individual and corporation, where more than 10 percent in value of the stock is owned directly or indirectly by the individual).
Reverse 1031 Exchange Alternatives
A reverse 1031 exchange is more complex and expensive than either a forward or simultaneous exchange. The EAT must file a federal tax return reporting the federal income tax attributes such as the acquisition, holding and selling of the parked property.
Alternative reverse 1031 exchange options to consider include:
- Wait until the old property sells, then proceed with a forward exchange
- Lease the old property to the Buyer with an option to buy, selling the property 180 calendar days prior to acquiring the new property. This option helps close the gap of time in a pre-construction contract or improvement exchange that requires more than 180 calendar days to complete, or to increase the percentage complete at time of transfer of burdens and benefits of ownership to the EAT
- Lease the new property from the Seller with an option to buy until the old property closes, then proceed with a forward exchange
The 1031 exchange requirement for a reverse is the same for a forward or simultaneous exchange. The debt retired and net equity from the old property sale must be equal to or greater in the new property to defer 100 percent of the recognized gain. The reverse 1031 exchange must be completed within 180 calendar days of the initial closing or Revenue Procedure 2000-37 does not apply.
To learn more about whether a reverse 1031 exchange makes sense for your transaction, call our office at 800.227.1031 or click below to ask your question and receive a follow up response within twelve hours.