In some circumstances, you may not meet the requirements for a typical 1031 exchange. Depending on the situation, you may perform a reverse 1031 exchange transaction to defer capital gains taxation on your investments. Read on to discover how it works.
You’ve decided you want to do a 1031 exchange to defer capital gains on your property sale. However, your replacement property is closing before you can sell your relinquished property. You can’t buy the new property in your name, or it won’t qualify for an exchange with your current property. What are you going to do? For these cases, you can still do the 1031 exchange, but it is considered a reverse 1031 exchange. A reverse 1031 exchange transaction allows you first to purchase the new investment property, and then sell your existing investment.
In a reverse exchange, a Qualified Intermediary (QI) takes title to the property that the individual wishes to purchase in an LLC (formed solely for this exchange) until the existing investment property sells. The LLC, in this case, is also known as an Exchange Accommodation Titleholder (EAT). The reverse exchange must be completed within 180 days. The 180-day clock starts on the date the QI purchases the replacement property for the taxpayer. Midland 1031 would then “park” the property in the LLC until you close on the sale of your current property. Within the 45 days of purchasing the parked property, an identification form must be completed identifying the relinquished property or properties that are to be sold. Once you close on your sale, we assign full membership in the LLC with the parked property over to you, making you the property owner.
How does a reverse 1031 exchange transaction work?
- You go under contract for the property you wish to purchase. Make sure that the contract is assignable because the title will be going in the LLC.
- Next, forward Midland 1031 a copy of the purchase contract and the title company’s or attorney’s contact information. If there is a mortgage on the property, we will need to know the lender’s contact details. You will need to notify the lenders immediately to let them know you’re doing a 1031 exchange. The loan documents will need to be in the name of the LLC established for the exchange.
- Then, Midland 1031 sets up the LLC that will take title to the property. We will provide closing instructions to the title company or attorney handling the closing.
- You must then identify all potential sales for the exchange to your QI within the first 45 days of the 180 days.
- Once you are under contract to sell your original property, Midland 1031 draws up the transaction documents on your sale. We then forward closing instructions to the title company handling the closing.
- You would proceed with the closing, and the title company would wire the proceeds directly to us. We would then use the proceeds to pay down any loans on your new property. If there is no financing on the new property, the proceeds would be disbursed to you.
- Once you close on your sale, we assign full membership in the LLC to you. You will now be the owner of the new property.
Before you start…
Before you do any 1031 exchange, you must notify your qualified intermediary before you close on any properties. One of the Certified Exchange Specialists (CES®) at Midland 1031 will guide you through every step of the exchange to ensure that the exchange is done properly.