Reverse Exchange Rules Explained

A reverse exchange flips the usual order of a 1031 exchange. In a standard delayed exchange, the investor sells the relinquished property first and then identifies and purchases replacement property. In a reverse exchange, the investor acquires the replacement property first, before the relinquished property has sold.

Section 1031 does not directly authorize this structure, because the statute assumes a sale followed by a purchase. Instead, reverse exchanges are built around a safe harbor described in Revenue Procedure 2000-37, using an exchange accommodation titleholder, often called an EAT. The EAT is a separate entity that takes and holds title to either the replacement property or the relinquished property on the investor's behalf, referred to as parking the property, while the rest of the exchange is completed.

In the most common version, the EAT takes title to the replacement property at closing, using funds the investor arranges, since the investor's own exchange proceeds are not yet available. The investor then has forty five days to identify which relinquished property will be sold to complete the exchange, and one hundred eighty days total to sell the relinquished property and have title to the parked replacement property transferred from the EAT to the investor.

Reverse exchanges are more complex and typically more expensive than standard delayed exchanges. Financing is often the biggest obstacle, since most conventional lenders are unwilling to lend directly to an EAT holding title on a temporary basis, which means investors frequently need cash, a bridge loan, or a lender familiar with parking arrangements to acquire the replacement property before the relinquished property sells.