Reverse 1031 Exchange
A reverse 1031 exchange is a tax-deferred like-kind exchange structure in which the investor acquires the replacement property before selling the relinquished property, using an Exchange Accommodation Titleholder to hold temporary title to one of the properties during the exchange period.
In a standard forward 1031 exchange, the investor sells first and then buys. In competitive real estate markets, however, investors often find desirable replacement properties before they have sold their existing holdings. A reverse exchange allows the investor to lock in the replacement property immediately without losing the 1031 tax deferral.
Because the IRS requires that the investor not simultaneously hold title to both the relinquished and replacement properties at the same time during the exchange period, a reverse exchange relies on an Exchange Accommodation Titleholder (EAT). The EAT — typically a single-purpose entity established by the Qualified Intermediary — holds title to either the replacement property (parking the acquisition) or the relinquished property (parking the disposition) while the investor arranges the other side of the transaction.
The IRS provided its safe harbor for reverse exchanges under Revenue Procedure 2000-37. Under the safe harbor, the EAT holds the parked property for no more than 180 days. Within that window, the investor must close on the sale of the relinquished property and complete the exchange.
Reverse exchanges are more complex and expensive than forward exchanges. Lenders are often reluctant to finance property held in the name of an EAT rather than the investor, which means the investor may need to use cash or creative financing to fund the replacement property acquisition. Legal and accounting fees are higher due to the additional entities and documentation involved.
Despite the cost and complexity, reverse exchanges are a valuable tool for investors in markets where replacement property is scarce and highly contested, or where a time-sensitive opportunity requires immediate action before the relinquished property is ready for sale.