Named for section 1031 of the Internal Revenue Code (IRC), the 1031 exchange is a hallmark tool for commercial real estate investors and business owners. It allows investors and owners to effectively delay capital gains taxes indefinitely. Read more about the standard 1031 exchange here.
While many investors are familiar with the standard “forward” exchange, the reverse 1031 exchange (“reverse exchange”) is an additional powerful lever that savvy investors should be familiar with.
What is a Reverse 1031 Exchange?
There is one key difference between a standard and a reverse 1031 exchange: timing.
In a standard forward exchange, an investor relinquishes an asset and then purchases the replacement property within the specified period. With a reverse exchange, the order of operations is inverted: the replacement property is acquired prior to the sale of the existing asset.
How Does a Reverse 1031 Exchange Work?
There is more nuance to consider with respect to reverse exchanges. There are both additional parties involved in the transaction and variations to the timelines specified by the IRC.
The process unofficially starts when the investor identifies a property they would like to purchase – the replacement property.
Step 1: Engage a Qualified Intermediary to act as Exchange Accommodation Titleholder (EAT)
The EAT is a role unique to reverse exchanges. Through a Qualified Exchange Accommodation Arrangement (QEAA) between the investor and the EAT, the replacement property can be “held” in a legal entity – like an LLC – on the investor’s behalf until the relinquished property is sold.
Step 2: Acquire the replacement property
The EAT uses funds provided by the investor to acquire the replacement property and holds the title on the investor’s behalf.
Step 3: Sell the relinquished property
Once the replacement property is acquired, there is a strict timeline for the investor to identify and then sell their existing property, starting from the day of closing on the replacement property:
- 45 days to identify which property is being relinquished.
- 180 days to sell the relinquished property and get the replacement property transferred.
Step 4: Complete the exchange and transfer the title
The reverse exchange is considered complete when, after the relinquished property is sold, the EAT transfers the title of the replacement property to the investor.
Who Should Consider a Reverse 1031 Exchange?
Reverse 1031 exchanges, while a powerful tool, are not appropriate for all investors given the strict timelines and complexity. A reverse exchange is helpful in the following example scenarios:
- Investors in fast-moving, competitive markets where waiting to sell their existing assets would cost them the opportunity.
- Investors who cannot sell their current property before buying. There are many reasons why an investor might not be ready to sell at any given moment, from market timing to completing capital improvements to being in the middle of lease negotiations that might impact the value of the asset.
- Investors with excess liquidity – or existing access to a financing partner. Reverse exchanges require an investor to have the capital in place for the replacement property without leveraging the proceeds of the relinquished property.
Key Benefits of a Reverse Exchange
You might be asking yourself: Why would someone want to buy their replacement property before selling their existing property?
It comes down to speed, control, and opportunity.
A reverse 1031 exchange allows investors to avoid market timing risks and act quickly in the event a deal comes across an investor’s desk that they cannot pass up. If the investor opted to go the standard 1031 exchange route, they’d have to bring their current property to market and wait for it to sell – meaning they’d likely miss out on the hot opportunity.
A reverse 1031 exchange also lets the investor take advantage of the opportunity without putting artificial time constraints on the sale of the existing asset, optimizing the selling conditions to get the best price. Bonus: the investor can start making capital improvements to the replacement property right away, before the exchange is complete – particularly helpful for bonus depreciation or value-add plays.
Challenges and Watch-Outs with Reverse Exchanges
For investors considering a reverse 1031 exchange, it is critical to consider and safeguard against the potential complications.
Reverse 1031 exchanges are more complex than standard exchanges.
Investors should be prepared for the additional cost and complexity of using Intermediaries/EATs. The first time working with an Intermediary – especially if not the right partner for the investor – dramatically impacts the success of the transaction.
Adding to the complexity, the IRC has strict requirements that must be followed for a successful exchange:
- The like-kind requirement applies to reverse exchanges as well as standard exchanges. This means that the relinquished and replacement properties must be of like-kind and held for investment or business use.
- The 45-day identification and 180-day transaction deadlines are firm. If not adhered to, the exchange can fail, making the replacement property ineligible for an eventual exchange of the existing property. While 180 days (~6 months) seems like enough time to execute a deal, commercial real estate can be notoriously clunky and susceptible to market fluctuations.
- Importantly, the IRC stipulates that the investor may not have possession of both the existing and replacement property at the same time.
With these challenges in mind, a reverse 1031 exchange may not be an appropriate strategy for investors who:
- Have time to sell the initial property before buying
- Have an asset to relinquish in a challenging market or condition
- Lacks sufficient liquidity
- Do not yet have established relationships with an EAT
FAQs About Reverse 1031 Exchanges
Can I use a reverse exchange for a residential rental?
Yes — if it’s held for investment purposes. Residential rentals, short-term rentals that meet IRS guidelines, and multifamily properties can all qualify. Personal-use assets are off the table.
Is a reverse exchange riskier than a standard 1031?
Slightly. The structure flips the order: you acquire the replacement property first, then sell the existing one. That shift introduces complexity — and more pressure on timing, capital, and execution. With the right advisory team and strategy, it can be a smart tool to protect gains and move quickly on the right opportunity.
What kinds of fees should I expect?
Reverse exchanges come with added structure — and additional cost. Most investors should expect:
- Qualified Intermediary (QI) fees for coordination and compliance
- Exchange Accommodation Titleholder (EAT) costs for temporarily holding title
- Legal counsel for entity structuring and risk management
How much time do I have?
The IRS timelines still apply:
- 45 days to identify the relinquished property (from the close date on the replacement property).
- 180 days total to complete the transaction. There are no extensions.
Do I need to pay all cash for the new property?
Not always — but you do need upfront access to capital. Traditional financing can be difficult since the title is often held by a third-party entity (EAT). Many investors use cash or short-term bridge financing to execute, then recapitalize after the sale.
Can I still take depreciation on the new property?
Yes. Your depreciation schedule continues, based on the adjusted basis carried over from the relinquished asset. A cost segregation study may be worth considering, depending on the value and type of the new property.
Who is a reverse exchange right for?
It’s a strategic fit for investors who:
- Have identified a strong opportunity and don’t want to lose it
- Are you navigating a low-inventory market
- Have capital flexibility and a trusted team of advisors
- Want to stay fully invested while deferring capital gains
For seasoned investors, a reverse exchange can be a valuable lever.
An Example in Action
A seasoned private investor with a portfolio of net lease retail, multifamily, and industrial assets is seeking to reposition part of the portfolio into a long-term, stable-income property in a competitive market.
The investor identified a newly built, credit-tenant industrial facility with a 20-year absolute triple net (NNN) lease. Demand for this asset type was high, and the seller would not consider contingencies tied to the sale of another property. The investor owned a Class B suburban office building, getting ready for sale, but the marketing process had just begun.
Without a strategy, the investor risks losing the industrial property — and the opportunity to lock in a higher yield and stronger tenant credit. In this situation, executing a reverse 1031 exchange allows the investor to acquire the industrial property quickly through the intermediary and continue with the sale of the office building. After acquiring the new property, the investor had up to 180 days to sell his relinquished property, successfully finalizing the exchange, deferring capital gains, and preserving equity for reinvestment.
The Numbers
Down Leg – Class B Suburban Office
- Purchase Price: $8.5M
- Sale Price: $14.2M
- NOI: $958,500
- Cap Rate: 6.75%
Up Leg – 400K SF Industrial Facility
- Purchase Price: $16M
- NOI: $1,136,000
- Cap Rate: 7.10%
Careful planning of a transaction like this would yield:
- $1.8M capital gains tax deferred
- +18% annual cash flow ($177,500)
- Upgraded to a credit-tenant, low-management asset
Practical Steps from SIG Advisors
Thinking about a reverse 1031 exchange? Here’s where to start.
Reverse exchanges require more than timing — they require precision. Before you move forward, take time to assess your position:
- Evaluate your timeline. Are you under pressure to act on a replacement property before selling?
- Consider market conditions. Is inventory tight or competition high in your target asset class?
- Check your capital position. Do you have the liquidity or lending in place to close before you sell?
Most importantly: find the right partner.
Reverse exchanges are highly structured. Success depends on having experienced advisors, legal guidance, and a qualified intermediary who understands your goals.
Learn more about Sands Investment Group’s financing partners and track record of success executing 1031 strategies.
Next Steps
Ready to put your capital to work? Request an introduction to a SIG advisor for a complimentary consultation.
Tags: 1031 Exchange, Reverse 1031 Exchange, Capital Markets
IMPORTANT INFORMATION
Sands Investment Group and its affiliates do not practice law and do not give legal, tax, or accounting advice. The information contained herein is for informational purposes only and is not intended to provide, and should not be relied on for legal, tax, or accounting advice. Investors should consult their own legal, tax, and accounting advisors before making any financial decisions. We are always available to collaborate with you and your trusted advisors as you plan your next steps.
