Our team often receives inquiries regarding whether an investor considering a 1031 exchange can buy a replacement property before they sell their existing property.
The short answer is yes, a taxpayer selling real estate can use the 1031 exchange process in reverse. Unlike a forward exchange, where sale proceeds are held in escrow, this arrangement involves “parking” the title to the replacement property with an exchange accommodator until the sale occurs. Parking arrangements come in several flavors; however, this overview focuses on scenarios where an investor can benefit from a reverse 1031 exchange. Please keep in mind that a reverse exchange applies to the acquisition of a new property and does not apply to properties for which the seller has already acquired title. It is not retroactive!
A reverse 1031 exchange enables an investor to purchase replacement real estate prior to relinquishing property and still obtain the tax benefits of a 1031 exchange. Although reverse exchanges are less common than a forward 1031 exchange where there is a sale followed by a purchase within 180-days of the sale; investors utilize reverse exchanges for a variety of reasons:
- Business Relocation – Where a business is relocating from the relinquished property to the replacement property, utilizing a reverse exchange can help minimize business disruption. A reverse exchange allows the business to acquire its new space and transfer property/employees to that space before closing on the sale of their old space, effectively allowing access to both spaces at the same time. Using a variation called an improvement exchange, the business has the option to build their new space to suit and can count the cost of the improvements as part of their exchange. This is a huge benefit for a company selling their old facility or office at a gain.
- Hot Market – In a “seller’s market” where properties remain on the market for a short period of time, the taxpayer can negotiate to buy a replacement property and park it with an accommodator. This eliminates the concern to meet the IRS 1031 identification deadlines (45-day period).
- Lock in the ideal replacement property – An investor locates a great replacement property; however, the relinquished property has not yet sold but will sell fast. The time to purchase cannot be extended to effect a forward 1031 exchange. The investor can take advantage of a valuable “buy opportunity” by closing the replacement property first and can utilize the full 180-day exchange period to complete the sale.
- Unexpected delay – The sale falls through or is delayed, and the investor is already under contract to purchase the replacement property. If the investor is unable to extend the time to close on the replacement property, a reverse exchange can be a solution to prevent a default and still benefit from a 1031 exchange.
As you can see, there are many factors that are involved in 1031 Exchanges. If you’re looking at an exit strategy for your asset, a forward or reverse exchange may be right for you. Please reach out to James Walther or a member of the Bledsoe Self Storage Group to discuss further.