What is 'Reverse Exchange'
A reverse exchange is a type of property exchange wherein the replacement property is acquired first, and then the current property is traded away. Reverse exchanges were created in order to help buyers who found a new property that they would like to purchase actually buy the new property before they were able to trade in or sell a current property. This may allow the seller to hold a current property until its market value increases, thereby also increasing their own timing to sell for maximized profit. Investors could use real estate trends and marketplace changes to improve investment opportunities using either a reserve or a delayed or referred exchanged. Generally, there is a maximum holding period that averages around 180 days.
The opposite of a reverse exchange is the delayed or deferred exchange, in which an exchanger must first relinquish owned property by trading or selling before acquiring new properly.
BREAKING DOWN 'Reverse Exchange'
Standard like-kind exchange rules usually do not apply to reverse exchanges. The IRS has created a set of safe-harbor rules that allow for like-kind treatment, as long as either the current or new property is held in a qualified exchange accommodation arrangement, or QEAA. Additionally, the investor cannot use property already owned as a replacement for the relinquished property.
Reverse exchanges apply only to Section 1031 property, so it is also referred to as a 1031 exchange. Section 1031 properties are properties that businesses or those with qualifying organizations exchange in order and defer paying taxes on any profit gained from their sale. However, it’s not as simple as an individual taxpayer buying one property, selling it, then using the profits to buy another property; instead, there must be a set standard of exchange and there is generally a facilitator used to set up the process. Section 1245 or 1250 properties are ineligible for this type of transaction.
How a reverse exchange works
One of the most crucial aspects of a successful reverse exchange depends on the fact that the investor must have the financial means for the new purchase. The new property will not have been relinquished at the time of the exchange, so the investor must provide for the full finding of the new property without it. Acquisition of the new property may be facilitated with a lender, although only specific lenders will be willing and able to work with a reverse exchange investor.