Delayed, Reverse and Improvement 1031 Exchanges: A Closer Look at the Key Differences

Delayed, reverse, and improvement 1031 exchanges are advanced strategies that allow businesses and real estate investors to achieve tax deferral under Section 1031 of the Internal Revenue Code (IRC) when they would otherwise be unable to do so. As a result, these strategies can be hugely beneficial for those with appreciated real estate assets and who can’t—or don’t want to—conduct a traditional like-kind exchange. With all three of these strategies, working with a 1031 accommodator is a necessary part of the process, and an experienced 1031 accommodator should be able to add value at each step along the way.

What do you need to know about delayed, reverse, and improvement 1031 exchanges—and which option (or options) should you choose? Here is a look at some of the key differences:

Delayed Exchanges: Buying Additional Time When You Need It

With a true “exchange,” the sale of the relinquished property and the acquisition of the replacement property happen at the same time. Of course, this presents some obvious logistical challenges, and for many businesses and real estate investors, conducting this type of simultaneous exchange simply isn’t an option.

This is where conducting a delayed exchange comes into play. By working with a 1031 accommodator, property owners can build additional time into the process. Under Section 1031, property owners have up to 45 days to identify a replacement property after selling their relinquished property, and they have up to 180 days to close on the replacement property’s acquisition.

To take advantage of this additional time, however, exchangers must avoid taking possession of the sale proceeds. They can do this by working with a 1031 accommodator who holds the proceeds in escrow until the closing date for the replacement property arrives.

Reverse Exchanges: Securing a Desirable Replacement Property Before It’s Too Late

Sometimes, the concern isn’t running out of time to conduct a 1031 exchange but rather losing the opportunity to acquire a desirable replacement property. As its name suggests, a reverse exchange allows the replacement property to be acquired first—with the sale of the relinquished property to take place at a later date.

Since the deadlines under Section 1031 run from the date of the sale of the relinquished property, there is nothing that prevents businesses and real estate investors from reversing the process. But strict rules and restrictions apply. Among them, to ensure that the combination of transactions still qualifies as an “exchange” for federal income tax purposes, a 1031 accommodator must take title to the replacement property temporarily. This is referred to as “parking” the property. Then, when the exchanger is ready to move forward with selling its relinquished property, the 1031 accommodator transfers the title to the exchanger as part of a federally compliant “exchange.”

Improvement Exchanges: Maximizing Tax Deferral Under Section 1031

Section 1031 of the IRC allows businesses and real estate investors to indefinitely defer federal tax liability by reinvesting gains from appreciated assets into new real estate acquisitions. If a 1031 exchanger receives any gains that it does not reinvest in a replacement property, these gains are classified as “boot,” and they are immediately taxable.

This presents a concern for those who want to use a portion of their sale proceeds to improve a replacement property: No matter how quickly the improvements are made, if they take place after closing, they will involve the use of taxable boot.

Exchangers can avoid collecting boot—and the immediate tax liability that comes with it—by conducting an improvement exchange. With an improvement exchange, the replacement property is parked (similar to a reverse exchange), and improvements are made before the exchanger takes ownership. This also involves working with a 1031 accommodator, who assists with forming an exchange accommodation titleholder (EAT) that owns the property during the improvement process.

By default, an improvement exchange involves elements of a delayed exchange—meaning that exchangers have up to 180 days to complete the buildout process and close on the replacement property’s acquisition. However, when necessary, an improvement exchange can be combined with a reverse exchange to extend the buildout timeline.

Schedule a Free Consultation with an Experienced 1031 Accommodator

So, which option (or options) should you choose? Our team can help you make an informed and strategic decision. To discuss your options with an experienced 1031 accommodator at 1031 National Services, give us a call at 888-872-1031 or tell us how we can help online today.