Timing is often the biggest obstacle in a 1031 Exchange.
In many situations, an investor finds the replacement property they want before the relinquished property is ready to sell. The seller may be prepared to close, but the property intended to fund the Exchange is still on the market or moving through escrow. Rather than risk losing the acquisition while waiting for the sale to catch up, many investors start looking for a way to buy first and sell later.
David Moore and Tom Moore, CEO and President of Equity Advantage, frequently work with investors facing exactly that timing issue and recommend they look into a Reverse 1031 Exchange. This version of a 1031 Exchange can make it possible to actually acquire the replacement property before the relinquished property sells. However, it’s very important that this structure be set in place before the acquisition ever closes.
The reason being that the taxpayer cannot own both the relinquished property and the replacement property at the same time. Once an investor owns both properties, the Exchange can run into problems. Creating separation between those two properties is one of the primary goals of the Reverse Exchange structure.
To create that separation, Reverse 1031 Exchanges rely on parking arrangements, Exchange Accommodation Titleholders (EATs), and specific timing requirements.
Reverse 1031 Exchange History and Safe Harbor Rules
Reverse 1031 Exchanges are not a new strategy. Elements of delayed Exchanges, simultaneous Exchanges, and reverse transactions have been around for decades and helped shape many of the concepts investors use today.
The modern framework became more structured with the introduction of the 45-day identification period, the 180-day Exchange period, and Revenue Procedure 2000-37. These all established safe harbor guidelines still shape how many Reverse 1031 Exchanges are completed today.
Understanding Parking Arrangements and the EAT (Exchange Accommodation Titleholder)
A Reverse 1031 Exchange generally follows one of two structures.
The first is a warehouse replacement structure, where the replacement property is parked until the relinquished property sells.
The second is a warehouse relinquished structure, where the replacement property is transferred to the taxpayer while the relinquished property is parked until it can be sold.
In a Reverse 1031 Exchange, “parking” a property simply means the EAT is holding title until the transaction reaches the point where the Exchange can be completed.
To facilitate either of these structures, an Exchange Accommodation Titleholder, commonly called an EAT, is created. The EAT is typically a single-member LLC that temporarily holds title during the Exchange process.
The Exchange is really taking place either now or later. The question is whether the replacement property or the relinquished property needs to be parked to keep the taxpayer from owning both properties at the same time.
How the Money Works in a Reverse 1031 Exchange
In a traditional 1031 Exchange, the relinquished property sells first and the proceeds are then used to acquire replacement property. A Reverse 1031 Exchange turns that sequence around.
That means that the funds which would normally come from the sale are not available yet, so the investor must provide the money needed to acquire the replacement property before the relinquished property is sold.
Consider a relinquished property worth $500,000 with a remaining loan balance of $200,000. If that property sells first, there would be $300,000 of equity available for the Exchange.
In a Reverse 1031 Exchange, the investor may only have a portion of that equity available upfront. To help bridge the gap until the relinquished property is sold, the EAT steps in and acquires the replacement property. The future sale will then provide the remaining equity needed to complete the Exchange.
A warehouse replacement structure can be especially useful when the investor expects to receive more equity from the future sale than they can initially contribute. Because the EAT remains on title, proceeds received later can be used to reduce debt before ownership is transferred to the taxpayer.
That flexibility can be especially valuable when only one replacement property is being acquired and additional equity will be coming from the future sale.
Reverse 1031 Exchange Timelines Still Matter
A Reverse 1031 Exchange provides flexibility, but the deadlines do not disappear.
The IRS still provides 180 days to complete the Exchange. Investors also generally have 45 days after acquiring the replacement property to identify the relinquished property.
Those timelines become especially important when multiple properties are involved.
Some investors may have several potential relinquished properties and may not know which one will sell first. A Reverse Exchange can still accommodate those situations, but the identification and completion deadlines still apply.
In some cases, investors may also combine Reverse and delayed Exchange components in the same overall strategy, particularly when multiple properties are involved.
Improvements During a Reverse 1031 Exchange
A warehouse replacement structure can create flexibility beyond simply solving a timing problem.
Because the EAT remains on title, improvements can be completed before ownership is transferred to the taxpayer. If additional value needs to be added to help satisfy Exchange requirements, that work can be completed while the property is parked.
This can be useful when a property is acquired at a value below the investor’s overall Exchange target and improvements are needed to increase the amount invested in the replacement property.
Reverse 1031 Exchange Risks Investors Should Understand
The biggest mistake investors make is assuming they can buy first and structure the Exchange later.
David frequently sees situations where a sale falls apart and someone decides to move forward with the acquisition anyway, hoping a Reverse Exchange can be added after the fact. Once the taxpayer takes ownership without the proper structure in place, the transaction may no longer qualify.
Because ownership, debt reduction, and future sale proceeds all affect the outcome of an Exchange, the structure needs to be established before the acquisition of the new property closes. Waiting until after the property is purchased can seriously limit available options and create complications that could have been avoided with proper planning.
Reverse 1031 Exchanges can be powerful tools when timing does not line up with a traditional Exchange. Understanding the ownership rules, parking structures, EAT requirements, and deadlines can be a big help when deciding whether acquiring first and selling later is the right fit for your situation.
If you are planning a 1031 Exchange and want to understand how a Reverse 1031 Exchange may affect your situation, contact Equity Advantage to speak with an Exchange expert and structure your 1031 Exchange with more flexibility and confidence.
The Guys With All The Answers…
David and Thomas Moore, the co-founders of Equity Advantage & IRA Advantage
Whether working through a 1031 Exchange with Equity Advantage, acquiring real estate with an IRA through IRA Advantage or listing investment property through our Post 1031 property listing site, we are here to help Investors get where they want to be. Call them today! 503-635-1031.
FAQs About Reverse 1031 Exchanges, EATs, and Parking
What is an EAT in a Reverse 1031 Exchange?
An Exchange Accommodation Titleholder (EAT) is an entity created to temporarily hold title to property during a Reverse 1031 Exchange. The EAT helps prevent the taxpayer from owning both the relinquished property and the replacement property at the same time, which is one of the key requirements of the Exchange structure.
How long do you have to complete a Reverse 1031 Exchange?
A Reverse 1031 Exchange generally must be completed within 180 days. Investors also typically have 45 days after acquiring the replacement property to identify the relinquished property that will be sold as part of the Exchange.
What does it mean to “park” a property in a Reverse 1031 Exchange?
Parking a property means the EAT temporarily holds title to either the replacement property or the relinquished property until the Exchange can be completed. Depending on the structure, the EAT may hold the replacement property until the relinquished property sells, or hold the relinquished property after the replacement property has been acquired.
