Structures
Reverse Exchanges: Buying Before You Sell
When the right replacement appears before your sale closes, a reverse exchange is the only structure that saves the deferral. It is also the most expensive.
Illustration generated for this article by 1031 Exchange News Today.
The ordinary 1031 exchange assumes you sell first and buy second. Reality frequently refuses to cooperate: the right replacement appears while your own property is still on the market, and the seller will not wait. A reverse exchange is the structure that saves the deferral, and it is the most expensive one in the toolkit.
Why you cannot simply buy first
Because you cannot own both properties at once and still qualify. The exchange requires that the replacement be acquired as part of the exchange, not before it, and property you already own outright cannot be exchanged into.
So somebody else has to own one of them for a while. That somebody is an exchange accommodation titleholder, usually a single-purpose LLC formed by your intermediary, which takes and holds legal title until the other side of the transaction completes.
The safe harbour
Revenue Procedure 2000-37 sets out the rules the IRS will respect. The accommodation titleholder must hold qualified indicia of ownership, a written qualified exchange accommodation agreement must be in place within five business days, and the whole arrangement must unwind within 180 days.
Park the new one, or park the old one
Two variants, and which one you use is usually decided by your lender.
| Structure | What the titleholder holds | When it is used |
|---|---|---|
| Exchange last (park the new) | The replacement property | Most common. Your relinquished property is still on the market. |
| Exchange first (park the old) | The relinquished property | Used when the lender will not finance a property held by an accommodation entity. |
Parking the new property is far more common, but it requires a lender willing to lend against an asset held by an LLC that is not you. Not every lender will, and finding out on day 40 is a bad way to discover it.
What it costs
Typically $5,000 to $10,000 or more, against $800 to $1,500 for a standard forward exchange. Those are market ranges rather than quotes, and the difference is structural rather than a matter of pricing policy.
You are paying for entity formation, the accommodation agreement drafted for your facts, insurance on a property the entity legally owns, lender negotiation, and up to 180 days of administration and eventual unwinding.
When it is worth it
When the alternative is losing the property. That is the honest test. Paying $7,000 to secure a building you would otherwise not get, while deferring a tax bill that is routinely six figures, answers itself.
It is not worth it for tidiness. Nobody should run a reverse exchange because the timing would be more convenient.
Disclosure
This article is published by Easy1031, a qualified intermediary with a commercial interest in readers starting an exchange. The rules and mechanics described here are the same whichever intermediary you use. Nothing here is tax or legal advice.
