Buy First, Sell Later: How a Reverse 1031 Exchange Works

The right building rarely appears on schedule. It appears while you are still deciding whether to sell, or two weeks before your listing goes live, and it will not wait 180 days for you to catch up.

A reverse 1031 exchange exists for exactly that situation. You acquire the replacement property first and sell the original afterwards, with the gain still deferred. It works, it is well established, and it is considerably harder than the ordinary version.

What is a reverse 1031 exchange?

An exchange in which the replacement property is acquired before the relinquished property is sold.

The complication is a rule you cannot design around: you are not permitted to own both properties at the same time and still call it an exchange. So the new property has to be held by somebody else until your sale completes.

That somebody is an Exchange Accommodation Titleholder, usually a subsidiary of your Qualified Intermediary, operating under a safe harbour the IRS set out in Revenue Procedure 2000-37. They take title and hold it, you fund the purchase, and when your old property sells the title transfers to you.

This is called parking, and the structure is a parking arrangement.

Which property gets parked?

Either, and the choice has consequences.

Parking the replacement property is the common route. The accommodator takes title to the new building and holds it while you sell the old one. You keep operating the relinquished property normally, which makes life simpler.

Parking the relinquished property means the accommodator takes title to the property you are selling, and you buy the replacement directly. This is useful when the new lender will not accept an accommodator on title, which lenders frequently will not.

Your intermediary and your lender will effectively decide this between them.

What are the deadlines?

The same as a forward exchange, counted from the day the accommodator acquires the parked property.

• ›45 days to identify the property you intend to sell
• ›180 days to complete the whole arrangement

Read that again, because it is the hurdle people underestimate. In a forward exchange, 180 days is the time to find and buy something. In a reverse exchange, it is the time to sell something, at an acceptable price, in whatever market exists that season. You cannot make a buyer appear.

If the sale does not complete inside 180 days, the structure unwinds, you take title to the new property and the exchange is lost.

What is the second hurdle?

Money. A reverse exchange requires you to fund the entire replacement purchase before you have received a penny from the sale.

You need cash, a bridge loan, or a lender willing to lend to an accommodation titleholder, and many will not. Those that do generally price it accordingly and want a personal guarantee. Where conventional financing is used, expect the underwriting to take longer precisely because the ownership structure is unusual.

The practical effect is that reverse exchanges suit owners with liquidity or strong banking relationships, and they are difficult for owners whose wealth is entirely inside the property they are selling.

What does it cost?

Materially more than a forward exchange.

Accommodator fees for a reverse structure commonly run several thousand to well over ten thousand dollars, against a few hundred to a couple of thousand for a standard delayed exchange. Add the entity formation, additional legal work, possible double transfer taxes depending on your state, and the carrying cost of financing the purchase early.

That is real money, and it is still usually smaller than the tax on an appreciated property. The calculation is not whether a reverse exchange is expensive. It is whether it is cheaper than the alternative.

When is it genuinely the right answer?

• ›The replacement is unique and will not wait. An off market building, an adjacent parcel, an unusual asset with no comparable substitute.
• ›You are already past day 45 on a forward exchange and the deal fell through. A reverse structure on a fresh timeline is sometimes the rescue.
• ›Your sale is complicated and slow but certain. A property with a known buyer and a long escrow can make a reverse exchange the safer ordering.
• ›Market timing genuinely favours buying now. Rarely as compelling as it feels at the time, but occasionally true.

When is it the wrong answer?

If you are doing it because you have not started marketing the property you intend to sell. A reverse exchange does not create time, it borrows it, and the 180 day sale deadline is far less forgiving than a 180 day purchase deadline.

If the replacement is a commodity asset with several equivalents on the market, the flexibility is not worth the cost and the risk.

What to do first

Speak to an intermediary who runs reverse exchanges regularly rather than occasionally, and speak to your lender before anything else, because financing is where these arrangements most often stall. Have a realistic conversation with your broker about how long your property will genuinely take to sell, then subtract a month.

Nothing here is tax, legal or investment advice, and rules and costs vary by state and change over time. Confirm your own position with your CPA, your attorney and a Qualified Intermediary before you act.