Most well-versed with Reverse 1031 Exchange timelines and rules, understand the standard forward process, usually involving the sale of real estate and then snapping up a replacement. A standard option in such transactions is to allow an individual to purchase a new piece of real estate before selling off the old one. This is part of a tax deferment strategy, allowing the investor that bought the property not to pay capital gains tax on the sale of the property. A good understanding of the whole process is key to being successful.
What is Reverse 1031 Exchange?
This is a real estate transaction that involves buying a replacement property before the sale of the one you ceded and transferred. A reverse 1031 exchange process involves specific properties—those that are 1031-eligible. These kinds of real estate properties are only for investment purposes. As such, your primary residence or any second home is not considered 1031-eligible. These transactions are only allowed when the investor has the finance to buy the new property without the windfall from the sale of the old one.
This process has the same timeline as that of a standard 1031 exchange. However, deliberate planning is required because the process is more complicated than the standard one. Whether an investor is doing this for the first time, the cost is always a crucial factor in these types of deals. For example, an investor may find that the cost of doing a reverse 1031 exchange is too prohibitive to be worth it.
Overview of a Reverse 1031 Exchange Process
Most states have streamlined creating standardized rates for all such transactions. A reverse 1031 exchange process involves the following steps:
- An investor starts by choosing an intermediary. This intermediary’s job is to hold onto the title deed of the new property until the old one has been turned over. The intermediary can be an individual or a holding company. The investor is not allowed to hold the title deeds of both properties simultaneously. This is usually the part of the process that requires significant legwork.
- The involved parties enter into an agreement, known as the purchase and sales agreement (PSA), to complete the transaction.
- Careful documentation is crucial here. The qualified intermediary is in charge of preparing the closing documents.
- There should be a PSA between the investor and the old property buyer. This is part of the crucial documentation needed to complete the reverse 1031 exchange transaction.
- v) All the involved parties sign all the necessary closing documents and agreements.
Rules of a Reverse 1031 Exchange
- For tax purposes, the buyer must also be the seller
- None of the real estate property involved can be a primary residence
- The replacement property should be of equal (or greater) monetary value
- Such transactions must reach completion in no more than 180 days from the date of initiation
Average Cost of a Reverse 1031 Exchange
Depending on several factors, an investor can expect to fork out between $4500 and $7500. Of course, it’s always a good idea to do your research and ascertain things for yourself. If you go with information gleaned from reliable sources, any estimate should include the cost of service. Depending on the jurisdiction where the reverse 1031 exchange takes place and the complexities involved, you can expect to pay a much higher price than the average.
Practical Considerations for a Reverse 1031 Exchange
1)Funding
An exchanger should have adequate financial means to buy the replacement property since he won’t draw on the proceeds of the relinquished property. Suppose the exchanger needs a loan to facilitate the transaction. In that case, a lender should be willing to give the loan to a collateral titleholder (EAT), the intermediary responsible for holding onto the property until its sale.
2) Parking
“Parking” refers to the act of a qualified intermediary or EAT taking hold of the property’s title during the transaction. This ensures that the investor doesn’t hold the titles of the replacement and relinquished property simultaneously.
Parking can involve either the relinquished property or replacement property. Depending on the source and availability of funds to pay for the transaction and whether or not third parties have a right to possess the said property (lien) temporarily, a qualified intermediary can choose which title to hold.
All in all, the more convoluted the reverse 1031 exchange process, the higher the costs involved.
