In previous articles, we covered the subject of reverse 1031 exchanges in a fairly detailed manner. We’ve introduced the two types of reverse exchanges—exchange first and exchange last—and went over the various reasons why an investor would want to conduct one of these transactions. We also reviewed the more nuanced aspects of reverse exchanges, like the concept of the “safe harbor” and how this regulation benefits investors.
In this article, we will review the “nuts and bolts” of reverse 1031 exchanges by walking through an exchange from start to finish.
The 9 Steps of a Typical Reverse 1031 Exchange Transaction
In total, there are nine steps that make up a reverse 1031 exchange. Viewing these nine steps will give you a good sense of the effort, energy, and resources that are involved in a basic reverse 1031 exchange.
- The first step of your reverse exchange is to develop a contract to acquire a suitable replacement property and arrange financing. Financing arrangements for reverse exchanged are fairly flexible: You can advance funds or choose third-party financing or seller financing.
- You then enter into a written agreement—a qualified exchange accommodation agreement (QEAA)—with your exchange accommodation titleholder (EAT) before your titleholder acquires qualified indicia of ownership. This written agreement may contain different provisions depending on which type of financing you arrange and also exactly how your EAT intends to hold the parked property.
- The third step is for your EAT to acquire title to the replacement property. This can only occur after a financing arrangement has been obtained by you. In many cases, your EAT will acquire title through a single purpose entity (SPE). This SPE is designed to minimize risk and guarantee that the assets involved will not be commingled with other assets of the EAT.
- You formally identify the relinquished property in either the QEAA or in a separate notice. The property (or properties) must be identified within 45 days of your EAT obtaining title to the parked property.
- In the fifth step, your EAT may lease the parked property to you provided that the lease period doesn’t exceed the safe harbor parking period. The lease will allow you to take control of the parked property in advance.
- Identify a buyer for the relinquished property and execute a formal sales contract with this buyer.
- You enter into a new agreement with a qualified intermediary (QI). The QI will acquire the right to transfer the title of the relinquished property to the new buyer. Also, the QI will obtain the right to gain title to the parked property.
- Your QI will require that you convey the relinquished property to the buyer through a deed. The buyer will then transfer the exchange funds directly to the QI. Subsequently, the QI will use these funds to acquire the parked property from the EAT. At this time, your EAT will identify any closing costs or other liabilities that need to be satisfied immediately and will use a portion of the exchange funds to cover these expenses.
- In the final step, the EAT deeds the parked property directly to you. Your QI will oversee this part of the transaction. Once you’ve received your deed, the 1031 exchange is finished.
Reverse Exchange Complexities
By their very nature, reverse 1031 exchanges are quite complicated and require diligence and persistence to complete. However, they are sometimes the only option if you wish to take advantage of section 1031.
Reverse 1031 exchanges are more expensive than traditional exchanges because of the complexity involved and also the number of professionals you must hire. Although it may be tempting to rush through such an exchange in the interest of saving money, doing so could result in costly mistakes.
At CWS Capital Partners, we’ve helped clients through countless reverse and traditional 1031 exchanges. Contact us today to get started with your exchange.
The information provided here is for your general informational purposes only. It should not be considered a recommendation or personalized advisory advice. CWS has made this third party information available from authors it believes are knowledgeable and reliable resources. However, its accuracy or completeness cannot be guaranteed and sentiment may change due to legal or economic conditions.
All investments involve risk including the possible loss of principal. You should familiarize yourself with all risks associated with any investment product before investing.
Advisory services are provided by CWS Capital Partners LLC, a registered investment advisor.
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