Reverse and Improvement 1031 Exchanges: When Buying First or Building Makes Sense

Most 1031 exchanges are forward exchanges: you sell first, then buy. But sometimes the right replacement property shows up before your sale is ready, or the property you want needs work before it fits your plans. That's where reverse and improvement exchanges come in.

The four exchange types

• Forward (delayed) exchange. Sell, then buy within 180 days. This is by far the most common.

• Simultaneous exchange. Both closings happen the same day. It still needs exchange documents in place before closing.

• Reverse exchange. Buy the replacement property first, then sell.

• Improvement (build-to-suit) exchange. Use exchange funds to make improvements to the replacement property before you take title.

How a reverse exchange works

You can't own both properties at once in a standard exchange, so the IRS safe harbor uses an Exchange Accommodation Titleholder (EAT). The EAT takes title to, or "parks," one of the properties, usually the new one, while you sell the other.

The timeline runs from the day the EAT acquires the parked property:

• Within 45 days, you identify which property you'll sell.

• Within 180 days, the sale has to close and the parked property has to be transferred to you.

Those 180 days are a hard limit under the safe harbor. Reverse exchanges also need financing worked out in advance, because the EAT is on title, and lenders need to be comfortable with that. Plan on more lead time and higher fees than a forward exchange.

How an improvement exchange works

In an improvement exchange, the EAT holds title to the replacement property while improvements are made with your exchange funds. The improvements have to be completed and the property transferred to you by day 180.

Only improvements actually completed by then count toward your replacement value. Money spent on work that isn't finished, or money left over, doesn't count and may be taxable. Build a realistic schedule with your contractor and leave room for delays.

One caution: you generally can't use an improvement exchange to build on land you already own. Talk to your tax advisor before planning around property you or a related party already hold.

Which one fits?

• Forward exchange: You have a buyer and time to find your replacement.

• Reverse exchange: You've found the right property and can't risk losing it while you sell.

• Improvement exchange: The property you want needs work, or you'd need to add value to replace what you sold.

Next step

Reverse and improvement exchanges take more planning than a standard exchange. If you're considering one, reach out early so we can walk through the structure and timing with you and your lender.

APX 1031 is a Qualified Intermediary. We don't provide tax or legal advice; talk with your CPA or attorney about your situation.