Author: Heather Connor, Crested Butte Lifestyle Agent
Let’s continue our journey into this fun tool called the 1031 Exchange.
Now, I know I sound like a complete nerd but I really am fascinated by this tool. And one of the biggest things I love about it is that it really is one of the simplest and most powerful tools for us to utilize as investors.
You did just watch the video on what a 1031 Exchange is and the 7 steps. And now, we are going to cover the FOUR (4) different types of exchanges.
The Delayed, Reversed, and Improved Exchange can be used singularly, in combination with another one, or even all three together which really shows you how you can start leveraging this tool for even further maximum tax-deferred benefits. The Simultaneous Exchange, however, is the only one, due to its nature must be used by itself.
1. The Delayed Exchange
This is the most common type of exchange. This happens when the exchanger sells the Relinquished Property first and then uses the sale proceeds to purchase a new property, which is known as the Replacement Property second.
When people talk about The 1031, this is usually what they’re referencing. It is the easiest because it allows you to carry forward your proceeds into the investment of a new property.
2. The Reverse Exchange
This is the opposite of a Delayed Exchange. It is a Tax-Deferred Exchange that effectively enables the purchase of a new (replacement) property before the sale of the old (relinquished) property. This is less common because you are not able to carry the equity forward.
There are 2 Options for the Reverse Exchange:
Option 1: Front-Leg Reverse Exchange – Essentially the exchange accommodation titleholder will take title to your old (relinquished) property. Which will then enable you to purchase and receive your new (replacement) property.
Option 2: Back-Leg Reverse Exchange – This is when the exchange accommodation titleholder acquires the replacement property and “parks” the ownership of it for up to 180 days.
The Reverse Exchange is great for a market when it is a seller’s market. And for example, having anything on the contract such as contingencies including the contingency upon the sale of a property to perform on purchase of a new property could greatly dampen your ability to be competitive and make an offer.
The power of the Reverse Exchange is if you have the financial ability to do this, then you can purchase that property first, just like you would any other property. Gives you leverage and power to be competitive in a seller’s market and you can then go back and sell the previous property and still take advantage of the tax-deferred benefits of the 1031 Exchange.
3. Improvement Exchange
This is also known as “Construction Exchange”. This is used when there is some amount of repair or replacement that needs to be completed on the Replacement property.
The Process and Completion of the Improvement Exchange:
1. The Investor sells the relinquished property, identifies a replacement property, and places it into the hands of a Qualified Intermediary, also known as a QI.
2. While in the QI’s hands, the investor can use the sales proceeds of the Relinquished Property for renovations on the Replacement Property.
3. Considers 3 conditions that must be met upon completion.
- Must be substantially the same (like-kind property);
- Construction must be completed within 180 days;
- The value must be equal to or greater than the Relinquished Property.
4. Simultaneous Exchange
This is exactly what it sounds like. In it, the Sale of the Relinquished Property and the purchase of the Replacement Property happen on the same day. Because of the nature of it, this is the only one that cannot be used in combination with the other ones.
Three ways that this can take place:
1. The Two-Party Trade – In a two-party trade, owners of the Relinquished Property and the Replacement property literally trade or swap deeds.
2. Three-Party Exchange – In a three-party exchange, there is an accommodating party and they act as an intermediary to facilitate the transaction.
3. The Qualified Intermediary – A Qualified Intermediary is an expert in the 1031 Exchange process, works with the buyer and the seller to manage the logistics.
The Simultaneous Exchange is the only exchange that does not require a QI. The reason that I can see somebody choosing to use this is they want to save the funds. The problem with it is, in my opinion, you put a tremendous amount of time pressure on yourself. So in your effort to save however much that QI might cost to perform the exchange between the buyer and seller. It also buys you time and so you may not need to pay however much the QI cost you run the risk of not completing it on the same day. And then again, having a failed exchange and as we know, in a failed exchange all it really means is you’re paying the taxes. You don’t get to defer and capitalize on that leverage which is the whole purpose of The 1031.
If you have any questions, or if you want any of these slides, you can go ahead and text me or my team with the number 970.440.2975.