While a taxpayer typically cannot use a traditional forward 1031 Exchange to acquire replacement property before selling their relinquished property, they may be able to use a Reverse Exchange.
Most 1031 Exchange transactions are structured as forward-delayed exchanges, where the taxpayer sells their relinquished property and then acquires replacement property within 180 days. However, in certain situations, the taxpayer may need to acquire replacement property before the relinquished property is sold. This can be accomplished through a Reverse Exchange.
In a Reverse Exchange, the Qualified Intermediary (QI) sets up a special purpose entity (SPE), typically a single-member LLC, to take title to the replacement property on behalf of the taxpayer. The taxpayer then provides the funds to the SPE, either by lending the purchase money directly or working with a lender. The taxpayer also assigns the rights to purchase the replacement property under the contract to the SPE, enabling it to complete the acquisition. Once the SPE acquires the replacement property, it leases the property back to the taxpayer under a triple-net lease, with the taxpayer managing the property as if the SPE didn’t exist—leasing, collecting rents, etc.
The taxpayer will continue to market and sell the relinquished property. When the sale is negotiated, the exchange proceeds are handled similarly to a traditional forward exchange. The taxpayer will assign their rights under the sale contract to the QI. At closing, the exchange funds will flow to the QI, as in a typical forward exchange.
However, rather than being used to acquire replacement property, the funds are used to pay down the loan that the taxpayer provided to the SPE. Once the loan is paid down, the QI will transfer the replacement property to the taxpayer, completing the reverse exchange.
While the Reverse Exchange process is more complex than a traditional forward exchange, it allows the taxpayer to acquire replacement property before selling the relinquished property. The entire transaction, however, must still be completed within the 180-day exchange period.
1031 Asset Solutions has dedicated specialist to help with Reverse Exchanges. Give us a call today at 844-401-1031.
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