One of the difficulties of executing a Forward 1031 Exchange is that there is limited time to identify suitable properties and an investor may miss the window to qualify for the 1031 "tax-free" exchange. Many of the current buying opportunities are either short sales or lender-owned properties. The timing uncertainties these generate make a Forward 1031 Exchange risky to execute well.
A Reverse 1031 Exchange allows investors to take advantage of current market opportunities by purchasing the replacement property FIRST, and then identifying the relinquished property within a designated time frame (most times investors KNOW which property they want to get rid of in advance).
As an investor, in order to decide whether to use a Forward or a Reverse 1031 Exchange, ask yourself:
- Will the replacement property still be available for me to buy after closing on the relinquished property?
- In the case of a multiple-offer scenario (such as a HUD property) - will I win?
- Will the lien holder(s) act in time in the case of a short sale?
- Do I wish to do buyer's due diligence?
- Can I be approved for financing?
- Can I complete the transaction fast enough?
In case the answers to any of these questions is "no" or "I don't know", a Reverse 1031 Exchange may be more suitable.This is how they work:
- Buy replacement property first & sell relinquished property later
- No tax consequences are locked in from the beginning (because you haven't sold any property yet)
- No risk of not closing on time on replacement property (takes the worry out of the timing of a 1031 Exchange)
- You can acquire the replacement property and start improvements using an Improvement 1031 Exchange while the relinquished property is being sold.
The advantage in this market is that you can move quickly to capitalize on opportunistic market situations, without triggering the "tax clock". You can still move forward with the purchase of a replacement property, even if your relinquished property doesn't sell (and not lose the opportunity of doing a tax-free exchange).
There are other, more sophisticated strategies that you can use with a Reverse 1031 Exchange, such as buying a promissory note as a replacement property. For these you will need the assistance of a 1031 Exchange expert. Contact us if you need one...