Reverse 1031 Exchange: Buying Before You Sell

A reverse 1031 exchange is an exchange run in the opposite order. You buy the replacement property first and sell the property you are giving up afterwards. Because the rules do not allow you to own both at the same time and still treat the transaction as an exchange, a third party holds title to one of them until the sale completes.

Most owners have never heard of it, and discover it only after they have been told they missed their chance.

Why would anyone do it backwards

The standard order is sell, identify within 45 days, then buy. That order puts the pressure in exactly the wrong place. The clock starts the day your sale closes, so you are searching under time pressure, often in a market where the properties you actually want are not available on the day you happen to need them.

The reverse order removes that problem. You find the property you want, you buy it, and only then do you arrange the sale. Nothing is being rushed into on day 44 because the alternative was a failed exchange.

In practice there are two situations where it comes up:

• ›The right replacement appears earlier than expected, months before you intended to sell, and waiting means losing it
• ›A seller will not wait for your sale to complete, so you have to be able to close first or walk away

How the parking arrangement works

You cannot hold the old property and the new one at the same time and still have an exchange. So one of them gets parked with a third party called an exchange accommodation titleholder.

There are two ways to arrange it. Either the titleholder takes title to the replacement property and holds it while you sell the old one, or the titleholder takes title to the property you are giving up while you buy the new one directly. Which one is used depends mostly on the financing and on what the lenders involved will accept.

The titleholder is not a nominee arrangement invented for the occasion. There is an established safe harbour that sets out how the parking is supposed to work, which is why the structure is a recognised route rather than something improvised.

The deadlines are the same numbers in different roles

A reverse exchange does not buy you extra time. It rearranges which deadline applies to which property.

• ›You still have 45 days to identify. The difference is that you are identifying which property you are going to sell, not which one you are going to buy
• ›The parking arrangement still has to be unwound within 180 days

So the clocks are the same length. If your sale takes longer than 180 days to complete, the arrangement cannot simply be extended because the market was slow. That risk sits with you from the day the titleholder takes title.

What makes it harder than a standard exchange

Three things, and the first is usually the one that decides it.

The financing. Because the titleholder holds title rather than you, the borrowing has to be structured for that. Not every lender will do it, and the ones that will often price it differently. This is the first question to ask, before anything else is arranged, because the answer determines whether a reverse exchange is possible at all.

The cost. There are more parties, more documents and more fees than a standard exchange. The arrangement has to be worth that cost, which usually means the property you are securing is genuinely hard to replace.

You are committed to selling. In a standard exchange, if you cannot find a replacement you have simply sold a property and paid tax. In a reverse exchange you have already bought. If the sale does not complete inside 180 days, you own both properties and the tax treatment you were planning for does not apply.

Who it tends to suit

Owners with the financial flexibility to carry two properties for a period, and a specific replacement they do not want to lose. It is not a route to take simply because the standard order feels stressful.

It is also worth saying plainly that the 45 day search problem has a cheaper solution for most people: start looking before you sell rather than after. A reverse exchange solves a timing problem you cannot solve any other way. It is not a substitute for preparation.

Questions worth asking before you commit

If you are considering one, these are the questions that tend to settle it quickly:

• ›Will my lender finance a purchase where an accommodation titleholder holds title, and on what terms
• ›What happens if the sale of my existing property takes longer than 180 days
• ›What are the total costs of the arrangement, including the titleholder, compared with a standard exchange
• ›Is the replacement property genuinely irreplaceable, or does it simply feel urgent right now
• ›Who is handling the exchange documents, and have they done reverse exchanges before

The short version

A reverse exchange is a recognised way to buy before you sell. It uses a third party to hold title so you never own both properties at once, it runs on the same 45 and 180 day clocks as a standard exchange, and it costs more. The financing is almost always the deciding factor, and the risk that your sale does not complete in time sits with you.

If the right property has appeared and selling first is not an option, it is worth a conversation with your Qualified Intermediary and your CPA before you assume the opportunity has gone. If you are simply worried about finding something good enough inside 45 days, the better answer is to start the search now, while you still have time on your side.

Nothing here is tax, legal or investment advice. Whether a reverse exchange is available to you, and whether it makes sense, depends on your own circumstances, your financing and your timing. Confirm the details with your own advisers before acting.