If you have an investment property and are thinking about selling it and purchasing another property, you need to know about the 1031 tax-deferred exchange. This procedure allows the investment property owner to sell it and buy like-kind property while also deferring capital gains tax. In this article, you’ll find a summary of the main points of a reverse 1031 exchange—an often overlooked sub-section of a 1031 tax-deferred exchange.

What Is a Reverse Exchange?

A reverse exchange is a property exchange when the replacement property is bought first, and then the current property is sold or traded away. It was created to help buyers buy a new property before being selling or trade-in an existing property. This may allow the seller to keep the current property until the market value increases, thereby choosing the right time to sell for maximum profit. 

Things you need to know about the reverse exchange:

• Reverse exchanges are different from delayed exchanges, where the replacement property has to be purchased after selling the current property.

• Timing issues still apply, so check with your accommodator as to what time frames you must meet.

• “Reverse exchanges only apply to 1031 properties and are only allowed when investors have the means to make the purchase.

• Like-kind” exchange rules usually don't apply to reverse exchanges.

How a Reverse Exchange Works

Standard like-kind exchange rules typically do not apply to reverse exchanges. Such rules usually allow a property investor to discontinue capital gains taxes paid on a property they have sold, as long as the profit from that sale is planned to purchase a “like-kind” property. The IRS has set safe-harbor rules that allow the like-kind treatment, so long as either the current or future property is in a qualified exchange accommodation arrangement. The investor can also not use property that's already owned as a replacement for the resigned property. 

Reverse exchanges only apply to Section 1031 property, so it is also called a 1031 exchange. Section 1031 properties qualify organizations and businesses to defer paying taxes on any profit they gain from their sale. However, it’s not enough that an individual taxpayer buys one property, sells it, then uses the profits to buy another property. Instead, there has to be a set standard of exchange and also the presence of a facilitator who is there to set up the process. Section 1250 or 1245 properties are ineligible for this kind of transaction.

For an investor, there are several reasons why you may want to consider a 1031 exchange. Some of those reasons are:

● If you own investment real estate, or you might be searching for a managed property instead of managing one yourself.

● You may want to diversify assets, or you may be looking for a property that has better return prospects.

● You might want to consolidate multiple properties into one, for example, for estate planning purposes or to divide one property into various assets.