In the normal course of events, when you sell real property and realize a gain on the investment, you are subject to capital gains taxes. For example, if you purchased a property for $100,000 and later sell it for $150,000, you may be required to pay capital gains taxes on the $50,000 gained as a result of the sale. The Internal Revenue Code, Section 1031, however, allows certain transactions to qualify for a deferral of the payment of capital gains taxes. In order for a transaction to qualify for a 1031 exchange, you must purchase “like-kind” property to replace the property you sold. Under certain circumstances, you may be able to purchase the replacement property first by using a reverse 1031 exchange.
1031 Exchange Rules
Originally, the exchange had to be accomplished simultaneously; however, that requirement has been relaxed somewhat over the years. Currently, you have 45 days after the sale of your property to identify the replacement property, and up to a total of 180 days after the original sale to complete the purchase of the replacement “like-kind” property. Sometimes, identifying and purchasing the replacement property within the time frame allotted after the sale of your property can be difficult. Since the clock starts ticking once you sell your property, you will be under pressure to find a qualifying “like-kind” property. Because the rules are strict with regard to what qualifies as a “like-kind” property, a seller may be concerned that once the original property has been sold, a suitable “like-kind” replacement property will not be located and identified within the 45 days allowed under a traditional 1031 exchange.
If you are unable to locate a qualifying property within the time allowable under Section 1031, you will lose the benefit of the deferral and incur capital gains taxes on the original sale. As a result, purchasing the replacement property first often makes more sense. This type of exchange is referred to as a reverse 1031 exchange.
Reverse 1031 Exchange
As the name implies, a reverse 1031 exchange operates essentially the same way as a traditional 1031 exchange, except in reverse. The replacement property is purchased first and may held by an Exchange Accommodator Titleholder until the original property is sold. Once you have purchased the replacement property, you have 45 days to identify the property you plan to sell and 180 days to actually complete the sales transaction. Although there is still pressure to make sure the original property sells within the 180 time frame, at least you already know that a qualifying replacement property has been identified and purchased.
To learn more about reverse 1031 exchanges, read the following related articles:
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