1031 Reverse Exchange – Example of Success

What is a 1031 Reverse Exchange?

The 1031 Reverse Exchange is used when the Exchanger needs to acquire a target Replacement Property before selling the Relinquished Property. The reason it has to be set up as a Reverse Exchange is because the IRS statute does not allow property already owned by the exchanger to be replacement property. This means that if the exchanger were to take title to a target Replacement Property before they sell their Relinquished Property, they would already own it when the Relinquished Property sells, and it would not be eligible to be purchased as a Replacement Property at that time.

To account for this timing issue, the Exchanger and a Qualified Intermediary (QI) must use a “Parking Arrangement” to properly complete a Reverse Exchange. A Parking Arrangement is an agreement between the QI and the Exchanger where the QI will agree to take and hold title to a property for the benefit of the Exchanger. Another key part of the Parking Arrangement is the use of an Exchange Accommodation Titleholder entity, commonly referred to as the “EAT.” This is typically a single-member LLC, where the QI is the single Member. This is the entity the QI will use to receive title to the Parked Property. Later, after the Exchanger’s Relinquished Property is sold, the Exchanger will complete the exchange by purchasing the “Parked” Replacement Property from the EAT.

Want a deeper dive on a 1031 Reverse Exchange? Check out the article, 1031 Exchange Types & Key Rules to Follow

How a Feed Store Owner Used a 1031 Reverse Exchange to Support Business Expansion

When the owners of a successful feed store in Texas wanted to expand their operation by moving to a bigger property, they realized that selling their current location would result in a large taxable gain. Not to mention the timing of the move was everything – they had an established and loyal customer base who relied on them for feed and supplies for their livestock, so they needed to make sure the business kept operating seamlessly.

These requirements made them a great candidate for a 1031 Reverse Exchange. When the owners embarked on the process, they started by identifying a new location that was better suited for their growing business needs. Then, they worked with Ten31 Texas to initiate a Parking Arrangement and the contract was secured for the new property. 

Ten31 Texas set up an EAT specifically for the Reverse Exchange and the Exchanger provided 100% of the purchase funds in the form of a loan to the EAT. The EAT completed the property purchase and concurrently with the closing, the EAT signed a lease with the Exchanger, allowing them to occupy the property, and they began moving their business operations to the new location. 

This approach enabled the owners to begin transitioning their business to the new location while simultaneously marketing the property associated with their former business location. The owners then focused on selling the property, and when it was sold, Ten31 Texas was engaged as the QI and received the net sale proceeds from this Relinquished Property as Exchange Funds. 

After that, the feed store owners, referred to as the Exchanger, were able to complete the 1031 Reverse Exchange by taking title to the Replacement Property that had been “Parked” with the EAT. The property was deeded to the Exchanger, and all available Exchange Funds were paid to the Exchanger as a debt reduction payment on the prior loan. 

Conclusion

For property owners who want or need to purchase a Replacement Property before selling their current property, a 1031 Reverse Exchange may be the answer to maximize the benefits of tax deferral and unlock the full potential of real estate investment opportunities.

Connect with Ten31 Texas to see if a 1031 Exchange is right for you. As a Qualified Intermediary, with years of experience handling 1031 Exchanges of all types, we can help you navigate any exchange process with confidence.