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Reverse Or Delayed 1031 Exchange, Which One Should You Choose?

by Rishav

Do you know that while executing a 1031 exchange, you can acquire the replacement property first and then close on the sale of the relinquished property? Well, it’s called a Reverse Exchange. A reverse exchange is also a kind of 1031 exchange. The only difference is that it’s opposite to a normal 1031 exchange. Investors, pursuing reverse 1031 exchanges, need to acquire the replacement property before closing the sale of the relinquished property. Similarly, there are three other kinds of 1031 exchanges, which though provide the benefits of tax deferment, but are different from normal 1031 exchanges in one way or the other.

Delayed, Simultaneous, and Improved 1031 Exchanges also let you defer up to 100% capital gains tax. 

  1. Delayed Exchange – A delayed exchange is a typical 1031 exchange that allows investors to defer capital gains taxes on exchanging like-kind properties. The first step of a delayed exchange requires investors to sell the relinquished property. The Qualified Intermediary holds the proceeds of the relinquished property and reinvests it on the replacement property. Once you got the proceeds from the sale of your old property, you get a deadline of 45 days for identifying potential replacement property that must be acquired within the 180 days of the exchange.
  2. Simultaneous Exchange – Simultaneous exchanges aren’t any more popular among real estate investors. The reason is obvious. In a simultaneous exchange, an investor is required to sell the relinquished property and acquire the replacement property at the same time. Since investors need to acquire the replacement property the day relinquished property is sold, they barely get a minute of respite. 
  3. Improved or Built-to-suit Exchange – An improved exchange is a special kind of tax-deferred exchange that allows investors to repair the replacement property using the proceeds of the relinquished property. Another name for an improved exchange is ‘built-to-suit exchange.’ In an improved exchange, an investor can invest a portion of the proceeds on improving the replacement property. An improved exchange is possible in situations where the price of the replacement property is less than that of the relinquished property.

No matter how these forms of 1031 exchanges are different, they provide the same benefits. Similarly, the role of a Qualified Intermediary also remains the same in all these exchanges. For better understanding, let’s see the role of a Qualified Intermediary in a reverse exchange. 

Role of a Qualified Intermediary in a Delayed Exchange

  • The Qualified Intermediaries represent investors in reverse exchanges. Since section 1031 reverse exchanges require investors to purchase the replacement property first, your QI acquires the replacement property on your behalf. 
  • Upon successfully acquiring the replacement property, the Qualified Intermediary looks for a buyer for the relinquished property. 
  • The Qualified Intermediary holds the title to the replacement property until the relinquished property is sold. Under no circumstances, an investor is allowed to hold the title of both properties (replacement and the relinquished one) together. 
  • Once you sell your old property, your Qualified Intermediary transfers the title of the replacement property to you and completes the exchange.

It has become evident that Qualified Intermediaries play a vital role in 1031 exchanges irrespective of what kind of 1031 exchange it is. Though a reverse exchange also provides the benefit of tax deferment, it shouldn’t be your first choice. After all, investing in replacement property prior to the sale of the relinquished property may put investors in great financial risk. That’s why investors don’t often consider reverse exchanges as their first choice. 

Another risk associated with a reverse exchange is the possibility of not finding a potential buyer for your old property within a limited time. Such risks aren’t rare in reverse exchanges. That’s why it’s better to go for a delayed 1031 exchange rather than opting for a reverse exchange. 

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