Buying Your Replacement Property Before Selling? The Reverse 1031 Exchange

If the right property is available before yours has sold, a reverse 1031 exchange lets you buy the replacement before you sell the property you are giving up. Because you can't hold both in the same exchange, an exchange accommodation titleholder takes title to one of them and holds it for you, for no more than 180 days. It has to be arranged before you buy, not after.

Start with a planning conversation

A reverse exchange only works if it is arranged before you buy. So the useful first step is a planning conversation, ideally before you sign the purchase contract. Leah will ask about four things:

• The purchase. When the seller wants to close, and whether the contract can be assigned or closed in a titleholder's name.
• The money. Whether you are paying cash or borrowing. A lender has to agree to the structure.
• The property you are selling. Whether it is listed, and whether it can realistically sell within 180 days.
• How you hold title. In your own name, an LLC or a partnership.

From there you will know whether a reverse exchange is realistic, what has to be signed before the purchase closes, and who needs to be involved. It is general education, not tax or legal advice: your CPA and attorney decide how the rules apply to you.

Selling first after all? Then it is a standard exchange: see selling a rental property and the timeline.

How a reverse exchange differs from a standard one

In a standard (deferred) exchange you sell first, then buy the replacement within the 45- and 180-day limits. The regulations for deferred exchanges cover only that order. When the IRS issued them, it said they do not apply to exchanges where the replacement property is acquired first (Rev. Proc. 2000-37 §2.04).

For the buy-first order, the IRS published a separate safe harbor in Rev. Proc. 2000-37, later modified by Rev. Proc. 2004-51. An exchange accommodation titleholder (often a single-purpose LLC) takes title to the parked property under a written qualified exchange accommodation arrangement. For federal income tax purposes the titleholder is treated as the owner while the property is parked. You then complete the other half of the exchange within the time limits.

The IRS's own instructions put it simply: the like-kind exchange rules do not generally apply when you acquire the replacement before you transfer the relinquished property, but a qualified exchange accommodation arrangement can make the transfer qualify (Instructions for Form 8824).

When a reverse exchange makes sense

• You found the replacement first. The seller won't wait for your sale, and losing the property would cost more than the added structure.
• Your current property will take time to sell. A slow sale is the main risk in a standard exchange's 45-day identification window.
• The replacement is hard to substitute. An off-market building or a specific parcel can't be swapped for a back-up if a standard exchange runs out of time.
• You want to improve the replacement before you take title. The titleholder can hold the property while work is done (see improvement exchanges).

A reverse exchange needs money to buy before you sell: cash, a loan, or both. That is usually the deciding question.

What must be true before you sign the purchase contract

1. The titleholder is lined up. Title to the parked property has to go to the titleholder at the purchase closing. It can't be you, and it can't be a disqualified person such as your agent (Rev. Proc. 2000-37 §4.02(1)).
2. The contract can be assigned or closed in the titleholder's name. Your attorney checks this before you sign.
3. The lender agrees to the structure. If the purchase is financed, the lender has to be willing to lend in a structure where the titleholder holds title for up to 180 days. Ask in writing.
4. Your current property can realistically sell within 180 days. Price, condition and the buyer's contingencies matter as much as the tax rules.
5. You didn't already own the replacement. The safe harbor does not apply to replacement property you owned within the 180 days before the titleholder took title (Rev. Proc. 2004-51 §4.03). If you have already bought it in your own name, a reverse exchange can't be added afterwards.

The safe-harbor conditions

Under Rev. Proc. 2000-37 §4.02, as modified by Rev. Proc. 2004-51, property is held in a qualified exchange accommodation arrangement when:

1. The titleholder holds qualified indicia of ownership of the property (for example, legal title), and is not you or a disqualified person.
2. You intend the exchange. When title passes to the titleholder, it is your genuine intent that the property be the replacement or the relinquished property in a §1031 exchange.
3. Within 5 business days after the titleholder takes title, you and the titleholder sign a written qualified exchange accommodation agreement.
4. Within 45 days after the titleholder takes title to the replacement property, you identify the property you will give up, in writing, following the ordinary identification rules.
5. Within 180 days after the titleholder takes title, the parked property is transferred to you (as replacement property) or to a buyer (as relinquished property).
6. The combined parking time for the properties in the arrangement does not exceed 180 days.

Parking outside these terms is not automatically invalid, but the IRS gives no assurance for it (Rev. Proc. 2000-37 §3.02). If the conditions are not met, for example the parked property isn't transferred in time, the safe harbor simply doesn't apply (§3.04).

Park the new property or the old one?

The revenue procedure allows either:

Which one is practical usually depends on the lender and the title company. Parking the replacement is common when the purchase is financed in the titleholder's name. Decide this with your advisers before the contract is signed.

Two traps

• Owning the replacement already. Property you owned in the 180 days before the transfer to the titleholder doesn't qualify under the safe harbor (Rev. Proc. 2004-51 §4.03; Form 8824 instructions).
• Building on land you already own. "An exchange of real estate owned by a taxpayer for improvements on land owned by the same taxpayer does not meet the requirements of § 1031" (Rev. Proc. 2004-51 §2.05).

Reverse plus improvements

While the titleholder holds the replacement, improvements can be built on it. You, or a related party, may manage the property and supervise the work without breaking the safe harbor (Rev. Proc. 2000-37 §4.03(5)). Only what is in place when you take title counts as replacement property; work done after you receive it is not like-kind property. The 180-day ceiling still applies. See construction and improvement exchanges.

The timeline

In a reverse exchange the clocks start when the titleholder takes title, not when you sell. Day 5 (business days): the agreement is signed. Day 45: the property you will give up is identified in writing. Day 180: the parked property is transferred. In a standard exchange the 180 days can also be cut short by your tax-return due date; see the 1031 exchange timeline and the deadline calculator.

There are no routine extensions. Only IRS disaster relief under Rev. Proc. 2018-58 can postpone these periods, and only when an IRS notice covers your situation.

Other costs and questions to raise early

• Holding costs. While the titleholder holds the property, someone pays the loan, taxes, insurance and upkeep. Your agreement with the titleholder sets out how.
• Transfer and recording taxes. A reverse exchange can involve more than one deed: to the titleholder, then to you or your buyer. Whether a state or city taxes each transfer is a local question. Ask your closing attorney before you structure the deal.
• Control. The titleholder is the owner of record during the parking period. Your control comes from the written agreement, so read it.

Before you sign: checklist

Hypothetical — not a client and not a result. An investor owns a rental house and finds a small apartment building whose seller wants to close in 30 days. The house isn't listed yet. Before signing, the investor gets the lender's written agreement to lend to an accommodation titleholder, engages the titleholder, and confirms the contract can be assigned. At closing the titleholder takes title, and the agreement is signed within five business days. Within 45 days the investor identifies the house in writing as the property to be given up, lists it, and has to close its sale within 180 days of the titleholder's purchase. If the sale doesn't close in time, the safe harbor no longer applies, so the asking price and the buyer's contingencies matter as much as the tax rules.

Frequently asked questions

Can I buy the new property now in my own name and sell mine within 180 days?

Not under the safe harbor. The replacement has to be acquired through an exchange accommodation titleholder under a written agreement, and replacement property you owned in the 180 days before the titleholder took title is excluded (Rev. Proc. 2000-37 §4.02; Rev. Proc. 2004-51 §4.03).

When do the 45 and 180 days start in a reverse exchange?

When the titleholder takes title to the parked property. You have 45 days from then to identify the property you will give up, and the parked property must be transferred within 180 days, with total parking time no more than 180 days (Rev. Proc. 2000-37 §4.02).

Can I finance the replacement property?

Yes, if the lender agrees to lend in a structure where the accommodation titleholder holds title during the parking period. Confirm this in writing before you sign the purchase contract.

What happens if my old property doesn't sell by day 180?

The safe harbor stops applying, and the tax treatment is decided without it (Rev. Proc. 2000-37 §3.04). Plan a realistic price and a contingency with your CPA before you start.

Can I combine a reverse exchange with improvements?

Yes. The titleholder can hold the replacement while improvements are built, and you may supervise the work. Only improvements in place when you take title count, and the 180-day limit still applies (Rev. Proc. 2000-37 §4.03(5)).

Can I exchange my property for a building on land I already own?

No. Rev. Proc. 2004-51 says an exchange of real estate a taxpayer owns for improvements on land the same taxpayer owns does not meet §1031.

How is a reverse exchange reported?

On Form 8824 for the tax year of the exchange, like other like-kind exchanges. The form's instructions cover exchanges using a qualified exchange accommodation arrangement (Instructions for Form 8824).

Who you'll work with

Leah Badach is a Certified Exchange Specialist with 11+ years of 1031 exchange experience. Reverse, improvement and standard exchanges are all available. Before you sign, Leah confirms in writing which qualified intermediary and accommodation titleholder will be involved, and gives you their account, bond and insurance documents. You can verify the credential in the FEA CES directory.

Related: Exchange planning call · 1031 exchange timeline · Deadline calculator · Denver: buying before you sell · Construction and improvement exchanges · Questions to ask any qualified intermediary · 1031 exchange rules

Sources

• Rev. Proc. 2000-37 (2000-40 I.R.B. 308): §2.04 (deferred-exchange rules don't cover replacement-first exchanges), §§3.02–3.04 (outside the safe harbor), §4.02 (the arrangement's requirements), §4.03(5) (permitted management and improvement).
• Rev. Proc. 2004-51: §2.05 (improvements on land you already own), §4.03 (180-day prior-ownership exclusion).
• Rev. Proc. 2018-58, §17: postponement of deadlines under federal disaster relief.
• Treas. Reg. §1.1031(k)-1: deferred exchanges, identification rules and disqualified persons.
• Instructions for Form 8824: reporting, including exchanges using a qualified exchange accommodation arrangement.

Educational information, not tax or legal advice.