Sometimes the property you want to buy shows up before the property you want to sell is ready to close. That is where a Reverse 1031 Exchange can come into play.
A Reverse 1031 Exchange allows you to acquire replacement property before selling your relinquished property, but there are important rules that have to be followed from the start.
David Moore and Tom Moore, CEO and President of Equity Advantage, regularly work with investors who assume they can buy first and figure out the Exchange later. That assumption can create problems very quickly.
You Cannot Buy Replacement Property First and Set Up the Exchange Later
Many investors assume they can buy a replacement property now and convert the transaction into a Reverse 1031 Exchange when their existing property sells later. Unfortunately, that is not how a Reverse 1031 Exchange works.
Never close on a replacement property without talking to your Exchange company first. In a Reverse 1031 Exchange, you cannot own the relinquished property and the replacement property at the same time. That is why the structure has to be in place before the acquisition occurs. Once the acquisition closes, you cannot simply go back and set up a Reverse 1031 Exchange afterward.
A Reverse 1031 Exchange Must Be Set Up Before Closing
Timing matters in every 1031 Exchange, but it becomes even more important when a replacement property is being acquired before the relinquished property is sold.
The paperwork has to be in place before escrow goes to close on the acquisition. Investors cannot buy a property today and decide months later that they want Exchange treatment when the relinquished property eventually sells. The transaction has to be structured as an Exchange before the acquisition actually takes place.
The desire to secure a replacement property can make it tempting to focus on the acquisition first and sort out the Exchange details later. However, that approach can create major problems for Reverse 1031 Exchanges because the Exchange company must be involved before the acquisition closes. Waiting until after closing is often too late.
Full Tax Deferral Means Replacing Your Equity
The timing may be different in a Reverse 1031 Exchange, but the requirements for full tax deferral remain the same.
Tom explains that if your goal is full tax deferral, all of the equity from the relinquished property needs to move into the replacement property. The replacement property also needs to be equal to or greater in value.
If you meet those requirements, you can generally achieve full tax deferral.
You can certainly buy a lower-value property if that is what makes sense for your investment goals. Just understand that there may be a tax consequence. As Tom explains, going down in value is allowed, but you are likely going to pay some taxes.
Before moving forward with a Reverse 1031 Exchange, it is important to understand how the value of the replacement property and the amount of equity being reinvested may affect the outcome. This allows you to structure the Exchange around your goals instead of discovering the tax consequences after closing.
Buying Before Selling Requires Early Planning
A Reverse 1031 Exchange can be a valuable tool when the right replacement property becomes available before your relinquished property sells. Instead of missing the opportunity while waiting for the sale to close, it can help bridge the gap.
However, all of the planning and Exchange structure need to be in place before the acquisition occurs. Once the purchase closes, you cannot simply go back and create a Reverse 1031 Exchange afterward.
If you are planning a 1031 Exchange and want to understand whether a Reverse 1031 Exchange may fit your situation, contact Equity Advantage to speak with an Exchange expert and learn how to 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
Can I buy a replacement property before selling my current property in a 1031 Exchange?
Yes, but only through a properly structured Reverse 1031 Exchange. The Exchange has to be set up before the purchase closes, or it will not qualify.
What happens if I buy first and try to set up a Reverse 1031 Exchange later?
Once the replacement property is purchased without the Exchange structure in place, it generally cannot be converted into a Reverse 1031 Exchange afterward.
Why does timing matter so much in a Reverse 1031 Exchange?
The Exchange structure must be established before closing because you cannot own both the relinquished property and the replacement property at the same time within the Exchange framework.
