Did you know that you can conduct a 1031 exchange in different ways? Contrary to the traditional method where you are required to sell your investment property and invest the entire proceeds in a replacement property to defer the capital gain taxes, a reverse 1031 exchange requires you to purchase the replacement property before selling the relinquished property.
Moreover, similar to the traditional 1031 exchange, you must keep in mind the reverse 1031 exchange timeline and rules in this case.
So, if you are considering doing a reverse 1031 exchange, here’s what you must keep in mind.
What Is A Reverse 1031 Exchange?
As stated above, during a reverse 1031 exchange, an investor must purchase the replacement property before selling the relinquished property. Although it can be a little confusing, compared to the traditional 1031 exchange, the timeline you follow is the same as that for a traditional 1031 exchange.
The Cost For A Reverse 1031 Exchange
It’s true that the cost of a reverse 1031 exchange can be a little higher than that of a traditional 1031 exchange. It is because of the complications involved and the standard fees associated with these kinds of exchanges. Moreover, while the fees might vary from state to state, a reverse 1031 exchange might cost you somewhere around $4,500-$7,500.
Besides this, if you are planning to invest in multiple properties, the fees might be a little more, depending upon the property type. In short, the cost of each additional property can cost somewhere around $400-$600.
Though these costs might seem higher than that of a traditional 1031 exchange, a reverse exchange allows you to look for a replacement property before you actually sell your relinquished property. This means you wouldn’t have to worry about finding the right replacement property within 45 days.
Reverse 1031 Exchange Timeline
Here’s what you need to follow to successfully complete a reverse 1031 exchange and defer the taxes on your capital gains.
Step-1: Getting In Touch With A Qualified Intermediary To Create An Exchange Accommodator Titleholder Agreement.
If you have decided to do a reverse 1031 exchange, you must start by getting in touch with a Qualified Intermediary (QI) to create an exchange accommodator titleholder agreement (EAT).
This is required because during a reverse 1031 exchange, the exchanger cannot hold the title of both properties at the same time. So, an EAT is required to hold the title of a property until the relinquished property is sold.
Step-2: Entering The Sales And Purchase Agreement With The Seller
The next step requires you to enter a sales and purchase agreement with the seller of the replacement property.
Step-3: Preparing Documents For Closing
Once the sales and purchase agreement is designed, your QI prepares all the required documentation for the closing of the replacement property. The documents usually include the Pledge of Membership Interest, Qualified Exchange Accommodation Agreement, Lease for the first leg closing and Promissory Note.
Step-4: Identifying The Relinquished Property
If your relinquished property is parked with the EAT agreement, there is no need for identification. However, if the replacement property is parked with the agreement, you must identify the relinquished property as the property to be sold.
You get 45 days to identify the relinquished property and 135 days to sell off the property. Once the property is sold, the gains go to the bank account of the exchanger or to pay the loan on the relinquished property, if any.
Step-5: Entering The Sales And Purchase Agreement for The Relinquished Property
The next step is to enter the sales and purchase agreement with the buyer of the relinquished property.
Step-6: Final Closing And Signing
The final process includes signing the final deed and closing the transaction. If the relinquished property is parked with the EAT, the agreement will be signed by the EAT, while the exchanger will sign the deed of settlement.
In A Nutshell
While the process can seem a little challenging, it can be a great choice, especially if you don’t want the hassles of finding the right replacement property within the short 45-day ID period. Moreover, you must keep the timeline and associated rules in mind to successfully complete the exchange.
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