What Is a Reverse 1031 Exchange? (We Diagram It)

Last updated on June 28th, 2021 at 11:51 am

Rules of a reverse 1031 exchange | Diagram of a reverse 1031 exchange | Kinds of reverse 1031 exchanges | Pros and consFees and costs | Costs by leading companies | Reverse 1031 exchange example | FAQ 

A reverse 1031 exchange means the reverse of a conventional delayed 1031 exchange: Instead of selling your old property and then buying a replacement, you buy your replacement property first, and then sell your old property.

The reverse 1031 exchange works for investors who have a great, time-sensitive opportunity to buy and have to act fast to secure the property. 

The timeline of a conventional delayed 1031 exchange just won’t work.  

Rules of a reverse 1031 exchange

A reverse 1031 exchange has the same basic contours of a regular 1031 exchange, although there are some differences.

  • Investors have a 180-day exchange period to complete the sale of the relinquished property.
  • Investors have a 45-day deadline to identify the existing property they intend to sell.
  • The replacement and relinquished properties need to be “like-kind,” as defined by the IRS.
  • An exchange accommodation titleholder (EAT) must be used in addition to a qualified intermediary
  • You’ll want to use some form of safe harbor for your reverse 1031 exchange, as defined by the IRS.

A reverse 1031 exchange can be a little confusing, especially for novices. Consult with one of our vetted 1031 exchange experts and they’ll answer all your questions.

Is a reverse 1031 exchange the same as a reverse like-kind exchange? 
Yes. A reverse 1031 exchange, a reverse like-kind exchange, and even a reverse Starker exchange are all different terms for the same process.

Diagram of a reverse 1031 exchange timeline

This reverse 1031 exchange diagram illustrates how a reverse 1031 exchange unfolds, including what happens at each step of the exchange and all the relevant deadlines.

The 1031 exchange is invalid if any of those steps go wrong. 

Kinds of reverse 1031 exchanges

The exchange diagrammed above is commonly called an “exchange later” reverse 1031 exchange, and it’s just one of several kinds of reverse exchanges. Others kinds of reverse 1031 exchanges include: 

Exchange first 

In this kind of reverse 1031 exchange the exchange accommodation titleholder (EAT) purchases the relinquished property from the taxpayer, as long as that transaction takes place before the closing on the replacement property closing. It’s often necessary when a lender doesn’t cooperate with the EAT buying the replacement. 

Blended 

In a blended reverse 1031 exchange, some replacement closings occur first, but some also take after the sale.  Again, these exchanges can be confusing, even for those with some experience with 1031 exchanges. Talk to one of our vetted 1031 exchange experts to get some critical guidance.

The pros and cons of a reverse 1031 exchange

Let’s look at some of the positives and negatives of using a reverse 1031 exchange.
✅ Pros❌ Cons
Great for competitive markets. It allows you to purchase an available property quickly, without having to relinquish one first.More expensive than a regular 1031 exchange (See: Reverse 1031 exchange fees and costs).
If your current property has issues that may affect a quick sale, a reverse 1031 exchange can jump-start the process.You'll need to fund the purchase of your new property on your own or with the help of a lender. In a regular 1031 exchange you can use the proceeds from your initial sale.
You don't have to rush to find a replacement property within 45 days.If you fail to sell your existing property within 180 days, your reverse 1031 exchange will be invalid. You’ll be responsible for taxes.
More complicated than a regular 1031 exchange.

Reverse 1031 exchanges can be lucrative but they have many moving parts. If you’re considering using a reverse 1031 exchange, a great first step is to contact us to help walk you through the process.

Reverse 1031 exchange fees and costs

Reverse 1031 exchanges are more expensive than conventional 1031 exchanges, with reverse 1031 exchange base fees starting at $3,500. Fees increase rapidly in proportion to the size and complexity of the transaction.

For comparison, a conventional delayed 1031 exchange costs around $1,000.

Why does a reverse 1031 exchange cost more than a standard 1031 exchange? Two main reasons: interest income and complexity.

Interest income in a reverse 1031 exchange, explained

In a conventional delayed 1031 exchange, your qualified intermediary (QI) holds onto the sale proceeds of your relinquished property during the 180-day exchange period. Quite often, they keep part or all of the interest made on that money. 

Interest income makes up about two-thirds of a QI’s revenues. The direct fee they charge is the other third. So, interest is a huge part of their business model.

In a reverse 1031 exchange, you buy your replacement property before you sell your initial property, so there are no sale proceeds for your QI to hold onto — and, thus, no interest income. The QI makes up for this by charging a higher fee. 

Complexity of a reverse 1031 exchange, explained

In addition to a qualified intermediary, you’ll likely need to use an exchange accommodation titleholder (EAT) to hold onto the title of your new property while the exchange unfolds. 

An EAT generates more paperwork, including a separate tax return for the transaction.

Company➡️ Standard 1031 exchange fee↩️ Reverse 1031 exchange fee
1031 Corp.$1,250 (up to $1 million relinquished property value; fees increase above $1 million)$5,000 ($7,000 in Pennsylvania)
1031x$1,000Fees start at $5,000 (with no lender) and $7,000 (outside lender).
Asset Preservation, Inc.$1,000Variable
Exeter 1031$899$6,850
First American Exchange Company$1,000$10,000-$15,000, plus a fee of $1,500/$2,000 and $250 for each property in addition to first relinquished and first replacement. Other conditions also apply.
IPX 1031$1,200Fees start around $6,000 for a parked residential dwelling unit with no lender.
Old Republic Exchange$950Fees start at $7,000
Starker Services, Inc.$750 (plus $100 bank fee)$2,500 base fee, plus 0.25% on the most expensive property in the exchange, up to $1 million in value. Also 0.1% for every dollar over $1 million.

Reverse 1031 exchange example

Let’s say you’re buying a $750,000 property, and selling your $450,000 and $300,000 properties within 180 days.

Since this is a reverse 1031 exchange, and you’re buying your new property before you’ve sold your old properties, you don’t have the luxury of using sale proceeds to buy the new property. So whether you’re putting 10% down ($75,000), 20% down ($150,000), or buying outright, that money has to come out of your pocket. 

Right off the bat, you’d also pay a reverse 1031 exchange fee of, say, $6,000, plus an additional property fee of $300.

On top of that, many states require you to pay a transfer tax when you transfer the title of your new property to your exchange accommodation titleholder (EAT) and when the EAT transfers the title back to you. While transfer taxes vary widely from state to state, let’s say you have to pay a 1% tax. That would add $7,500 to each transfer, for a total of $15,000 just in transfer taxes.

If it takes a while for your initial property to sell, you may end up using most of your 180-day exchange period, and have to rush through the transaction before the deadline. If that’s the case, add a $300 rush fee.

For the reverse 1031 exchange described above, you’d end up paying just over $21,000, not including your potential $75,000 or $150,000 outlay for the down payment.

FAQ about reverse 1031 exchanges

Can I use a special purpose entity during a reverse 1031 exchange?

Yes. 

You can use a special purpose entity — typically an LLC set up by your qualified intermediary — to “park” your replacement property while your reverse 1031 exchange unfolds. 

Special purpose entities are completely legal entities, often used in corporate finance and reinsurance firms, to keep assets legally separate from the rest of an organization. 

In a reverse 1031 exchange, they can be an alternative to an exchange accommodation titleholder.

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