Reverse 1031 Exchange: Buy, Sell, Defer

Savvy landowners are already aware of the 1031 exchange that allows for the deferral of capital gains tax on the sale and purchase of a subsequent property for investment purposes. However, what if you’ve already found your replacement property before selling your relinquished property? Enter the reverse 1031 exchange.

First, the entity wishing to accomplish the exchange must enter into an exchange agreement with a qualified intermediary such as a law firm. The qualified intermediary must form a Limited Liability Company to serve as the Exchange Accommodation Titleholder (“EAT”). This is the entity that will hold title to the replacement property while the exchange is taking place. It is imperative that the entity wishing to accomplish the exchange assigns any and all rights to the purchase contract to the EAT. It is also recommended that the EAT funds the purchase of the replacement property and not through the entity directly (hence the term “qualified intermediary”).

Next, the relinquished property must be identified within 45 days of the purchase date for the replacement property. 180 days from the purchase date of the replacement property, the replacement property must be sold. All funds from the closing of the replacement property must be directed to the qualified intermediary. The qualified intermediary executes an assignment of stock to the entity completing the exchange. Now that the transfer has taken place, the next step is to make sure that the transfer is reflected correctly on the tax return for the entity that is buying/selling.

When everything is said and done, your accountant or whoever is responsible for your tax return is going to be the one responsible for ensuring that your capital gains taxes are deferred on your tax return. They’ll do this using Form 8824 from the Internal Revenue Service. Check with your applicable state to find out about opportunities for state tax returns as well. You should expect to provide your tax professional with at least a copy of the executed settlement statement.