1031 Exchange Series: Part 3 – Reverse and Construction 1031 Exchanges

Part 3: Reverse and Construction 1031 Exchanges

Reverse 1031 Exchanges

In a reverse exchange, you purchase the replacement property before selling your existing property. This type of exchange is more complex and requires careful planning and execution.

Process of a Reverse Exchange

1. Acquire Replacement Property: The new property is acquired first. This is done through an Exchange Accommodation Titleholder (EAT) who temporarily holds the title to the property.

2. Sell the Relinquished Property: Within 180 days, you must sell your original property.

3. Transfer of Title: Once the original property is sold, the title of the new property is transferred from the EAT to you, completing the exchange.

Challenges and Considerations

• Financing: Securing financing for the new property while still owning the old one can be challenging. Bridge loans are a helpful option to have here, which is why your banking relationships are so important to maintain.

• Complexity: The involvement of an EAT and the need for detailed planning make reverse exchanges more complex and costly than delayed exchanges.

Construction or Improvement 1031 Exchanges

This type of exchange allows you to use the exchange proceeds to improve a replacement property. This is ideal if you find a property that needs renovations or if you want to build on a new lot.

Process of a Construction Exchange

1. Sale of Relinquished Property: Sell your current property and transfer the proceeds to a QI.

2. Acquire Replacement Property: The replacement property is purchased through an EAT.

3. Make Improvements: Use the exchange funds to improve the property within 180 days.

4. Transfer of Title: Once improvements are complete, the title is transferred from the EAT to you.

Advantages of Construction Exchanges

• Customization: Tailor the replacement property to meet specific investment goals.

• Maximized Use of Funds: Use all exchange proceeds for property improvements, deferring more capital gains tax.

In Part 4, we will discuss the rules, restrictions, and potential pitfalls of 1031 exchanges to help you avoid common mistakes.