While a taxpayer cannot utilize a traditional, forward 1031 exchange when looking to buy replacement property prior to selling the relinquished property, they might be able to utilize a Reverse Exchange.
The Standard Forward-Delayed Exchange
Most 1031 exchange transactions are structured as forward-delayed exchanges, where the taxpayer sells their relinquished property first, and then acquires their replacement property within 180 days. This is the most common and straightforward structure.
But there are times when the taxpayer must acquire their replacement property before the relinquished property sells — perhaps because they found an exceptional opportunity that won't wait. This is possible through a process known as a Reverse Exchange.
How a Reverse Exchange Works
Step-by-Step: The Reverse Exchange Structure
- The Qualified Intermediary creates a special purpose entity (SPE) — typically a single-member LLC — that will take title to the replacement property on the taxpayer's behalf.
- The taxpayer lends the purchase money to the SPE or coordinates with their lender to do so. The taxpayer also assigns purchase rights under the contract to the SPE.
- Once the SPE acquires the replacement property, it leases the property to the taxpayer under a triple-net lease in exchange for the taxpayer's management expertise.
- The taxpayer operates the property as if the SPE did not exist — leasing it, collecting rents, managing it fully.
- Meanwhile, the taxpayer continues to market the relinquished property for sale.
- Upon sale of the relinquished property, the exchange proceeds flow to the QI — and instead of acquiring a replacement property (already done), the funds pay down the taxpayer's loan used to acquire the replacement.
- The QI then transfers ownership of the replacement property to the taxpayer, completing the reverse exchange.
The 180-Day Requirement Still Applies
The entire reverse exchange transaction process must still fit within the 180-day exchange period. This means the taxpayer must sell their relinquished property and complete the exchange structure within 180 days of the SPE acquiring the replacement property. Planning and timing are critical.
Is a Reverse Exchange Right for You?
The process is more complex and generally more costly than a traditional forward-delayed exchange. But for taxpayers who have found the ideal replacement property and cannot afford to wait for their relinquished property to sell first, it is a powerful and fully IRS-compliant strategy.
Contact our team at 1031 Ivy Exchange to discuss whether a Reverse Exchange is the right structure for your investment goals. This is a transaction that requires experienced legal counsel from the very beginning.