Guides

Reverse 1031 Exchange Explained

A reverse exchange flips the usual order of a 1031 transaction, allowing an investor to acquire replacement property before the relinquished property has sold, which matters in a competitive market where a desirable asset will not wait for your existing property to close. The Internal Revenue Service does not permit a taxpayer to simply hold title to both properties at once and call it an exchange; instead, reverse exchanges rely on a safe harbor structure set out in Revenue Procedure 2000-37, using an independent Exchange Accommodation Titleholder, commonly called an EAT, to temporarily hold title to one of the two properties. Two structures are common. In an exchange-first, or true reverse, structure, the EAT takes and holds title to the replacement property while the taxpayer arranges the sale of the relinquished property. In an exchange-last structure, the EAT instead takes title to the relinquished property while the taxpayer closes on the replacement property directly, then the EAT sells the parked relinquished property once a buyer is secured. Both structures are bound by the same one hundred eighty day limit on how long the EAT may hold parked title, and the forty-five day identification requirement still applies, though in a reverse exchange it applies to identifying the relinquished property being sold rather than the replacement property, since the replacement side has already been acquired. Because the EAT structure requires the investor, or a lender on the investor's behalf, to fund the acquisition of the replacement property before relinquished property proceeds are available, reverse exchanges typically require more available capital or bridge financing than a standard forward exchange, and lenders experienced with parked-title arrangements are not universal, so financing needs to be arranged early. For a Seattle, WA investor who has identified a strong replacement asset in a market where offers move quickly, a reverse exchange can be the difference between securing that property and losing it to a buyer who does not need to coordinate a simultaneous sale, but the structure carries meaningfully higher transaction costs and documentation complexity than a standard exchange, so it is worth evaluating that tradeoff early with your qualified intermediary and lender. The Exchange Accommodation Titleholder is typically a special-purpose entity, often a single-member limited liability company formed specifically to hold parked title, and its formation, insurance, and eventual dissolution all add legal cost on top of the qualified intermediary's standard fee. Lenders vary considerably in their comfort with parked-title arrangements, and some conventional lenders decline to finance a property held by an accommodation entity altogether, which is why early conversations with a lender familiar with reverse exchange structures tend to save the most time. Investors weighing a reverse exchange against simply waiting to sell first should also account for the carrying cost of holding two properties, even briefly, including any bridge loan interest, since that cost offsets some of the benefit of securing the replacement property early.