When Would You Consider a 1031 Reverse Exchange?

Every passing day, more people are beginning to learn about the many benefits within a "Reverse 1031 Exchange". While it is more of a complex transaction than a standard 1031 exchange, the reverse exchange provides for a much greater flexibility in structuring the 1031 exchange.

There are many reasons for setting up a reverse exchange, but the one major reason is to solve the critical issue of finding a way, to take ownership of the replacement property, prior to the sale of the original property in the 1031 exchange. The IRS tax code does NOT allow for the exchanger to exchange into a property already owned. In this case the reverse 1031 exchange becomes the best answer when one has found, and is ready to close on the replacement property. This all happens while your still trying to sell the old, original property. Another reason to setup a reverse 1031 exchange includes securing your replacement property to avoid the risk of possibly loosing that property. Also this rids yourself of the replacement property "dilemma" once you have sold that old (original) property, because there is a short 45 day window to find a suitable replacement investment property.

Now that you have decided that a reverse 1031 exchange is the answer for your exchange needs. The next question becomes, what are the type of reverse 1031 exchanges should I choose from. Believe it or not, there are a number of different and viable options available in reverse 1031 exchanges. The most popular choices include:

• A Safe-harbor Reverse 1031 Exchange - This is a transaction whereby the Qualified Intermediary (QI) takes control or "parks" the replacement property prior to the sale of the old, original property. The exchanger is forced to identify the relinquished property or properties within the 45 days of the parking arrangement. They must also have the entire transaction completed within 180 days of the parking arrangement, as per IRS tax code. This structure falls within a revenue procedure set forth by the IRS tax code in the year 2000 and it also provides the guidelines in structuring this type of transaction or Exchange. If it is properly structured within the provisions of the revenue procedure, the US IRS will treat this to be within a "safe-harbor." They will not challenge the transaction based upon its status as a reverse 1031 exchange. This is the safest and most secure type of reverse 1031 exchange, but it is the most difficult to accomplish due to its short time frames that we are working with.

• The Traditional 1031 Reverse Exchange - This is a reverse 1031 exchange that in most cases looks identical in structure to the "Safe harbor" reverse 1031. Yet it will fall outside of the "safe harbor" due to the fact the exchange can't be completed within the time frames provided. Traditionally, the exchanger is not able to sell their old, original property within 180 days of the parking arrangement. This means the time frames set forth by the "safe harbor" are not going to be met. This type of transaction is NOT typically a RED FLAG for an audit (by the IRS), but does require a lot more documentation and consultation by the Qualified Intermediary (QI). This has to be done to assure the transaction (1031) is done properly to avoid any scrutiny by the IRS.

• The Construction or Improvement Reverse 1031 Exchange - This type of reverse 1031 exchange allows the exchanger to "park" a small or large piece of property or land that will be built upon or improved upon during the 1031 exchange period. This can be and is the most powerful reverse 1031 exchange available because it allows the exchanger to literally create the exchange 1031 property. This is the property that they will eventually 1031 exchange into through the construction or development process. As stated before, this is a much more complex transaction than a "safe harbor" reverse 1031 exchange and requires a lot more documentation and paperwork. One other downside to this type of transaction (1031) is that it will most likely fall outside of the time frames set forth by the "safe harbor." This pitfall has not scared off many 1031 exchangers as many builders are more than willing, to take on that small risk for the tremendous flexibility provided by this type of 1031 reverse exchange.

• The Leasehold Improvement Reverse 1031 Exchange - This type of 1031 reverse exchange is still in question as it has not officially been recognized by the US IRS as a valid and legal structure. This 1031 reverse exchange is where the exchanger will actually build on property they already own. Thus treating the building as the "parked" property. Technically, it is NOT the building that becomes the parked property, but rather a 35 year ground lease entered into between the Qualified Intermediary (QI) and the exchanger. This is the actual Vehicle that becomes the exchanged property. As you can see, this too is a highly complex transaction and must have too much supporting documentation to even think about supporting its structure. The complexity and questionable legality of this 1031 exchange has not deterred demand for it, as a matter of fact many exchangers are beginning to turn to this type of structure in taking care of their 1031 exchange needs.

This gives you an Idea of the many 1031 options that are available when implementing the reverse 1031 exchange. 1031 exchange made simple, will encourage you to speak with one of our Qualified Intermediaries (QI) to learn more about this very powerful tool. Lets see how this type of Exchange can directly benefit you.