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Reverse 1031 Exchange Cost

September 12, 2023

Wondering how much a reverse 1031 exchange costs? Most real estate investors are already familiar with the forward 1031 exchange. It entails the sale of a relinquished or old property to acquire a replacement property. The reverse 1031 is the flip side of the typical 1031 exchange – you buy a replacement property before selling the existing property.

In this article, we will explore the concept of reverse 1031 exchange, its benefits, the various costs involved, and how you can manage the costs and make informed decisions.

Understanding the Costs Involved in a Reverse 1031 Exchange

Understanding the Costs Involved in a Reverse 1031 Exchange

The cost of a reverse 1031 exchange is generally higher when compared to the forward exchange cost. This is because of its complexity and standard fees that vary from state to state.

The reverse 1031 exchange cost ranges from $4,500 to $7,500 on average. Another factor that greatly affects the costs is the number of properties involved in the exchange. Each additional property could cost between $400 and $600.

Now let’s have a look at each of the costs involved.

Qualifying Replacement Property (QRP) costs

The qualifying replacement property cost is the total expenses incurred in the purchase of the replacement property. They include the cost of the property, the real estate agent commissions, legal fees, and other expenses associated with the purchase.

QRP costs differ depending on the complexity of the transaction, the property’s market value, the real estate agent, your location, etc.

Exchange Accommodation Titleholder (EAT) Fees

Exchange Accommodation Titleholder (EAT) Fees

The EAT is a company that ensures you adhere to the 1031 exchange rules by holding the title to your replacement property or relinquished property. There is no standard or fixed amount for EAT fees. Hence, the cost depends on the negotiations between the investor and the EAT.

Closing Costs

This refers to the expenses directly related to the sale or purchase of real estate properties. Examples of closing costs include title insurance, escrow fees, legal and document fees, attorney fees (if applicable), survey fees, etc.

Interim Financing Costs

The interim financing costs in a reverse 1031 exchange are the expenses involved when you obtain short-term financing for a new property purchase.

Short-term financing can be a loan that covers other related expenses such as interest and prepayment penalties, depending on the lender. Ensure you carefully evaluate potential interim financing costs and determine their anticipated benefits in acquiring a property.

Holding costs

This is the accumulative ongoing cost of maintaining ownership of your replacement property during the period of parking. Holding costs include property maintenance, property taxes, and insurance premiums.

Professional fees

The professional fees are expenses you pay to various professionals associated with facilitating the exchange transaction. These professionals include legal consultants, tax advisors, and qualified intermediaries. The legal consultants ensure compliance to IRS regulations, while the tax advisor guides you in matters related to taxation.

The Qualified Intermediary (QI) plays a crucial role in facilitating your reverse exchange. They safeguard and disburse your exchange funds, prepare the necessary documentation required for the exchange, and much more.

Basics of the Reverse 1031 Exchange

Basics of the Reverse 1031 Exchange

The reverse 1031 exchange is also known as parking 1031 exchange. It is a type of 1031 exchange that allows you to buy a replacement property before selling your relinquished property. The new property must have equal or greater value than the old property. Unlike the traditional 1031 exchange, reverse exchanges allow property owners to hold their old property until it appreciates as long as it’s within the IRS timeline.

During the holding period, you can’t own the new property and the relinquished property simultaneously. To tackle this, the IRS has formulated rules that guide reverse exchanges, presenting a safe harbor under the Revenue Procedure.

According to the IRS, the Exchange Accommodation Titleholder (EAT) takes temporary ownership of either the existing property or the new property on your behalf. The target property is then parked in a single-member limited liability company (SMLLC).

It’s important to note that the EAT must transfer either the parked new property to you or the parked relinquished property to the buyer on or before 180 days. You have 45 days to report the potential relinquished property after acquisition by the EAT.

If you exceed these timelines for a reverse 1031 exchange, you won’t be qualified for tax deferment, meaning that your gains may be taxed. Nevertheless, the IRS can extend these deadlines by 120 days if the exchanger approves for disaster extension under the Revenue Procedure.

Benefits of a Reverse 1031 Exchange

Benefits of a Reverse 1031 Exchange

The reverse 1031 exchange offers many strategic advantages which include:

Tax Deferment Opportunities

One of the goals of a reverse 1031 exchange is to defer the recognition of gains until you sell the relinquished property within the timeline. You can enjoy the tax deferment benefit as long as you comply with the requirement of purchasing a property of similar or higher value to the relinquished property.

Less Timeline Pressure

The traditional 1031 exchange timeline puts pressure on investors to find the replacement property within the 135 day deadline. But with a reverse exchange, you have enough time to research, identify, and acquire the new property first before selling the relinquished property.

Maximizing Capital for Reinvestment

Reverse 1031 exchanges involve finding a new investment property at a fair price and then strategically selling the relinquished property at a higher price.

Potential Drawbacks and Challenges

Potential Drawbacks and Challenges

There are challenges and drawbacks that you have to consider as a property owner before initiating a reverse 1031 exchange. They include:

The complexity of the transaction. The reverse exchange may subject you to interim financing and arrangements associated with holding a property. Also, factors such as additional legal considerations and financial expenses contribute to its complexity.

Increased costs compared to a traditional 1031 exchange. Reverse exchange involves various expenses that are not involved in a forward exchange; for example, the EAT costs and financing costs.

Necessity for a qualified intermediary and potential risks. To be successful in the reverse exchange, you have to hire an expert, reliable, and qualified intermediary.

Real-world Scenarios: Case Studies

Successful Reverse 1031 Exchange Example

Mr. Buddy Gigglestein owns a commercial property close to the Metropolitan Museum in New York City.  Being motivated by a significant increase in value over time, he wanted another valuable property nearby.

However, due to high capital gains taxes, he couldn’t afford both properties at the same time. To tackle this limitation, Mr. Buddy opted for a reverse 1031 exchange and with the help of a QI, he successfully acquired the new property for $580,000 while holding the current one.

In compliance with the IRS regulations, the QI set up an EAT to temporarily hold the new property while he lists the relinquished property for sale. Within the exchange timeline, the value of the current property increased. He then sold it for $585,000, minus the $5,000 spent on exchange costs incurred during the purchase.

Tips for Managing Reverse 1031 Exchange Costs

The reverse 1031 exchange aims to defer tax liabilities while maximizing potential returns. As a result, you must ensure that reverse 1031 exchange costs are reduced to the barest minimum. The following tips can help you manage reverse exchange costs.

Work with experienced professionals. The QI, EAT, and other experienced professionals help you prevent costly errors and delays by guiding you through the process and ensuring that you comply with IRS requirements.

Find competitive financing rates that fit your budget. Ensure that you select a lender with a lower interest rate to minimize cost in the long run.

Plan and prepare appropriately to reduce surprises. This enables you to allocate resources effectively to avoid sudden financial challenges.

Keep a comprehensive checklist and timeline. Stay organized and on track throughout the exchange process.

Conclusion

The reverse 1031 exchange is loaded with many benefits and, of course, challenges. Apart from deferring tax on capital gains, other benefits include flexibility in your investment strategy and the leverage to increase reinvestment capital, thereby producing more returns.

On the other hand, major challenges include complex transactions, short timelines, increased costs, and uncertainty in the market as property may devalue over time.

Understanding the cost a reverse 1031 exchange helps you plan well and make informed investment decisions. It helps you minimize surprises, create a detailed financial budget, allocate resources efficiently, and manage your risks.

Finding your way around the reverse exchange process can be challenging and burdensome. Therefore, you need the oversight of an experienced, Qualified Intermediary like the Universal Pacific 1031 Exchange.

Do you have questions or need assistance? Or would you like to get started on your exchange journey? Reach out to us today.

About The Author

Michael Bergman, CPA
Michael Bergman is a California licensed CPA and Real Estate Broker with over 32 years of experience in commercial real estate. Specializing in 1031 tax-deferred exchanges and financial oversight, his expertise is invaluable for complex real estate transactions. Michael’s unique blend of financial acumen and real estate knowledge positions him as a trusted advisor in the industry, offering sound advice and strategic insights for successful property management and investment.

Don’t let taxes hinder your property investment decisions. Connect with us today for a free, no-obligation 1031 exchange consultation. Let us help you navigate the process with ease.