Types of 1031 Exchanges

Types of 1031 Exchanges

There are different types of exchanges that all offer the same tax advantages built into 1031 exchanges.

Which exchange is right for you depends on the value of your property, whether you are selling your relinquished property or buying your replacement property first and whether improvements are involved. 

Choosing the right type of exchange is key.

Standard Exchange

SELL FIRST THEN BUY
 
The most common type of 1031 Exchange occurs when you want to sell your current property and then buy a replacement property. 
 
 
 

Reverse Exchange

BUY FIRST, THEN SELL

 

A reverse 1031 exchange allows you to buy a replacement property first and then sell your current property. Reverse exchanges allow you to take advantage of buying the right property when it becomes available OR when you want to avoid the restriction of identifying a replacement property within the 45-day window required in a standard exchange.

 

Improvement Construction Exchange

WRAP IMPROVEMENTS INTO YOUR EXCHANGE
 

If your replacement property is priced significantly lower than your relinquished property, you may be able to wrap the cost of necessary improvements to the replacement (new) property into the value. This can be done as either an Improvement Exchange or a Reverse Improvement Exchange.

 
 

Standard Exchanges

These exchanges allow you to sell your Relinquished property and buy your replacement property either on the same day or over a maximum 180-day timeline.

Standard "Delayed" Exchanges

Delayed Standard 1031 exchanges involve the sale of a relinquished investment property and the purchase of a replacement investment property. A delayed exchange occurs when the replacement property closes within 180 days from the sale of the relinquished property. This is the most straightforward and common type of 1031 Exchange.

Standard "Simultaneous" Exchanges

Simultaneous Standard Exchanges can happen in two ways. The first way involves two parties who “swap” properties with each other. The second way is when the exchanger closes on the sale of the relinquished property and buys the replacement property on the same day.


Reverse Exchanges

Reverse exchanges allow you to buy a replacement property and then sell the property you already own, the relinquished property, later. 

There are two types of Reverse Exchanges: Replacement Reversed or Forward Reverse Exchange. 

BUY REPLACEMENT PROPERTY BEFORE SELLING RELINQUISHED

Replacement Reverse Exchange

When performing standard 1031 exchange transactions, investment property sells first. After this sale, the seller buys a new piece of real estate. A reverse exchange allows you to buy the new property before selling the existing one.

IRS Revenue Procedure 2000-37 sanctions the reverse exchange “safe harbor” rule. This procedure provides a parking arrangement for investments. Suppose a seller cannot sell the existing property within the standard 1031 exchange time frame. In that case, an Exchange Accommodation Titleholder (EAT) can hold title on the desired property until the first property sells. The seller is then able to take possession of the new investment parcel from the EAT.

Reverse Exchange Rules

  • Reverse exchanges have a 180-day deadline. The 180-day countdown starts on the date the EAT buys the replacement property for the taxpayer/seller.
  • Within 45 days after the purchase of parked property, the taxpayer must formally identify the relinquished property(s).
  • The EAT and the taxpayer must complete a Qualified Exchange Accommodation Agreement.

When a Reverse Exchange Is Useful

  • The owner of the investment property finds the ideal replacement property before finding a buyer for the exchange property.
  • The real estate investor needs to buy prime real estate as it enters the market.
  • Real estate sellers wish to avoid identifying replacement property in the 45 days required by a 1031 exchange.
FINANCING INVOLVED?

Forward Reverse Exchange

Often, a taxpayer considering a reverse exchange will not have the cash to fund purchasing the new replacement property. They often need financing for the purchase. Depending on the lender’s financing structure restrictions, it may not be possible to park the replacement property in the name of the Exchange Accomodator Titleholder (EAT). The taxpayer may be able to structure a "Forward" or "Relinquished Reverse Exchange." Here, the taxpayer parks the relinquished property with the EAT rather than the replacement property in the EAT. Using this approach, the taxpayer transfers their interest in the relinquished property. Doing this allows them to buy the replacement property in their name. Certain restrictions apply for completing this type of exchange. 

Forward Reverse Exchange Rules

  • In a Forward Reverse Exchange, the EAT takes title to (or parks) the relinquished property. Doing this allows the taxpayer to directly acquire the replacement property. Exercise caution before deeding the property to the EAT if there is a loan on the relinquished property. This may not be an option if there is a loan on the relinquished property.
  • Forward Reverse exchanges have a 180-day deadline. The 180-day countdown starts when the EAT takes title to the relinquished property.
  • Within 45 days after taking title of the parked property, the taxpayer must formally identify the replacement property to be acquired.
  • The EAT and the taxpayer must complete a Qualified Exchange Accommodation Agreement.

When A Forward Reverse Exchange Is Useful

  • The lender on the replacement property will not allow the taxpayer to finance/take the title in the EAT's name.
  • The owner of the investment property listed for sale finds the ideal replacement property before finding a buyer for the exchange property.
  • The real estate investor needs to buy prime real estate as it enters the market.
  • Real estate sellers wish to avoid identifying replacement property in the 45 days required by a 1031 exchange.

Improvement Construction Exchange

An Improvement Construction exchange is useful when the taxpayer is in the 45-day identification period and finds a replacement property that is significantly lower than the Net Selling Price (NSP) of the relinquished property, but the property needs work/improvements.

The taxpayer can use the Improvement Exchange to equalize the exchange value by including the value of improvements made to the replacement property. Please contact us to discuss your specific situation as these transactions are complex.

There are two types of Improvement Construction Exchanges: Standard Improvement Construction Exchange and Reverse Improvement Construction Exchange

SELL FIRST THEN BUY

Improvement Construction Exchange 

In an Improvement or Construction 1031 Exchange, the proceeds from the relinquished property sale are used to acquire the replacement property and make the desired improvements. This exchange is also known as a “Build-to-Suit” Exchange.

The property must be held (parked) by an Exchange Accommodation Titleholder (EAT). The EAT must hold the property until either the improvements are completed, or the 180-day exchange deadline occurs. On or before the 180th day, the improved property must transfer to the exchanger as the replacement property.

Improvement Exchange Rules

  • Improvement exchanges have a 180-day deadline starting on the sale of the relinquished property.
  • Within 45 days of closing on the sale, the taxpayer must formally identify the replacement property(s) and desired improvements.
  • EAT must take title to the replacement property while the improvements are made. (If the taxpayer were to take title to the replacement property, the value of the improvements would not be sheltered in the exchange).
  • The EAT and the taxpayer must complete a Qualified Exchange Accommodation Agreement.
BUY FIRST THEN SELL

Reverse Improvement  Construction Exchange

Reverse Improvement Exchanges allow the taxpayer to acquire the replacement property before closing on their relinquished property. These exchanges incorporate improvements to the replacement property to increase the property's value.

Reverse Improvement Construction Exchange Rules

  • An EAT Exchange Accomodation Titleholder (EAT) must take title of the replacement property and hold the title while the improvements are made.
  • Reverse improvement exchanges have a 180-day deadline. The 180-day countdown starts on the date the EAT buys the replacement property for the taxpayer/seller.
  • Within 45 days after the purchase of the parked property, the taxpayer must formally identify the relinquished property.
  • The EAT and the taxpayer must complete a Qualified Exchange Accommodation Agreement.