As a real estate investor, you must be aware of the usefulness of a reverse 1031 exchange. Generally, every investor encounters the challenge when they need to close on their replacement property prior to closing on the property they intend to sell. Reverse 1031 exchanges can be of utmost help in these situations. Similarly, real estate investors can utilize reverse exchanges when they are low on funds.
The reverse Section 1031 exchange allows the investor to buy time, which they can utilize for determining the appropriate replacement property and then close the deal with the help of the reverse exchange. Consequently, it becomes convenient for the investor to sell the property and getting the necessary time to sell it with the stipulated time frame.
Reverse Exchange- An overview
The reverse exchange facilitates the real estate investor to close on the acquisition of any replacement property prior to selling the relinquished property to a third-party buyer. The procedure initiates with the aid of having a limited liability company owned by First American Exchange Company.
The First American Exchange Company performs the role of a qualified intermediary and is in charge of creating a limited liability company. It is this company that bestows the responsibility of taking the title of the property. The company follows the IRS’s safe harbor rules of Revenue Procedure 2000-37. It makes it mandatory to complete the transaction within 180 days of the first closing. According to the safe harbor rules, the entity taking title to the property is referred to as an “exchange accommodation titleholder” or EAT.
It is the responsibility of EAT of owning the parked property, while the real estate investor requires bearing the necessary expenses of the said property, and simultaneously the investor also collects the sale proceeds. This is where, the investor benefits, since EAT remains the owner of the parked property, the investor need not involve in paying taxes for the sale proceeds.
Pros and Cons of a reverse 1031 exchange (exchanging last)
The main benefit that real estate investor gets, they can successfully defer paying taxes. Since EAT takes the title of the replacement property, the investors can save more money for future investments in acquiring good property deals.
The reverse exchange also offers the investors the convenience of borrowing funds that they can expect to get from the relinquished property. Later, they can repay the loan amount when a successful closing of the property is complete. Thus, investors are never short of funds. Additionally, the investor gets the freedom of exchanging the entire funds from the sale proceeds into the replacement property, without having to worry about paying tax.
By taking the title to the replacement property, the investor need not make hasty decisions on the properties they require disposing of while performing the exchange. The investors get a time of 45 days from the closing of the replacement property for identifying which property they prefer to sell.
In situations, where EAT takes title to the replacement property, and the real estate investor needs to borrow funds secured to the said property, the EAT can sign a few or all of the loan documents. In this procedure, the loan needs to be totally non-recourse to the EAT. Precisely, the EAT is not liable to repay the loan. Thus, according to the rules, it lets the investor guaranteeing the loan if they require to do so,
However, not all investors like the idea of the EAT being the borrower. Especially, when the loan is secured by a one to four-unit residential property, things can become complicated. When the parked property is actually the replacement property, it becomes mandatory for the investor to discuss in detail about the reverse exchange with the lender and tax advisor.
The benefits of parking the surrendered property (Exchange First)
By letting the EAT take title to the relinquished property it does not require the EAT to sign loan documents. Meanwhile, the investor can procure a loan by securing the replacement property. However, if there is an ongoing loan. In such circumstances, the investor must determine if the lender has the right to approve the transfer to the EAT.
As the EAT takes title to the surrendered property, the investor must invest the appropriate equity into it. Similarly, there are some other complicated issues to which the investor must be aware of. In certain circumstances, the investor may not be able to over-borrow on the replacement property making it difficult for them to repay the loan. Owing to this factor, any reverse exchange dealing with such relinquished property works properly when the investor has constant access to funds from other sources.
As a real estate investor, if you make note of the points discussed above, the reverse 1031 exchanges can be very helpful.