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What is a Reverse 1031 Exchange?

The reverse 1031 exchange is actually a misnomer. It represents an exchange in which the exchanger locates a replacement property and wants to acquire it before the actual closing of the relinquished or exchange property. Since the exchanger cannot purchase a replacement property then sell a relinquished property and expect to exchange into the new property that he already owns, he must find a method to purchase the replacement property and still maintain the integrity of the exchange.

Reverse 1031 exchanges are typically accomplished in two formats based on transaction logistics and the financing needs of the exchanger. The Exchange Last strategy is utilized only when the exchanger requires traditional financing to complete the acquisition of the replacement property. Since few lenders would lend dollars to the exchanger with a facilitator or qualified intermediary, known in this case as an exchange accommodation title (EAT) holder on title, it is necessary for the facilitator to warehouse or hold the title to the relinquished property.

In this approach, the reverse 1031 exchange is complete at the moment the exchanger accepts title to the new replacement property. However, with the prospect of the exchange being complete, it is necessary to balance equities between relinquished and replacement properties prior to the closing. In other words, upon closing of the replacement, there must be an equal amount of equity in the replacement property as is expected to come out of the later sale of the relinquished property. Then at the time of the later sale of the relinquished property, any debt is retired and the exchanger is repaid any dollars that he advanced for the replacement property acquisition.

In an Exchange First scenario, the facilitator, with the aid of a loan from the exchanger, acquires the replacement property and warehouses or holds the property title until which time that the relinquished property is sold and the exchange can be completed.

At this point, we need to express a couple of caveats regarding reverse exchanges. Because they require extensive planning and involve the holding of title by a facilitator in the form of an exchange accommodation titleholder, reverse exchanges tend to be more complicated than other exchanges. Do not undertake a reverse exchange without the assistance of an experienced and knowledgeable facilitator or intermediary.

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