Friday, February 07, 2014

Reverse Exchange Activity Has Increased

What Is A Reverse 1031 Exchange?

Most real property investors are familiar with a regular Forward 1031 Exchange whereby an investor sells his or her current rental or investment property and then exchanges into another property in order to defer the payment of their taxable gains.  The sale of the relinquished property occurs first and the subsequent purchase of their replacement property must occur within 180 calendar days from the date of the sale.  The Reverse 1031 Exchange is the opposite whereby the real estate investor can buy their replacement property first and then sell their relinquished property later.  Reverse Exchanges can give an investor a leg-up in high velocity real estate markets like today.

1031 Exchange Activity Up Substantially

You have no doubt read numerous articles recently that have been discussing news that 1031 Exchange transaction activity is way up.  We have not only heard but have experienced the same thing.  1031 Exchange volume has in fact exploded over the last 12 months or so, and the exchange activity trend continues to look very good indeed.

Reverse Exchanges Increase More Than Regular Exchanges

As we analyzed our 1031 Exchange transaction detail, we noticed an underlying trend - Reverse 1031 Exchange activity had not only jumped as well, but had jumped significantly more than Forward 1031 Exchanges on a percentage comparison basis.  It's certainly not surprising when one looks at the underlying real estate market velocity - its been a crazy real estate market.  Investors are competing with multiple offers and bidding wars in many real estate markets.  This can make a Forward 1031 Exchange stressful for the less sophisticated investor due to the strenuous 1031 Exchange deadlines involved. 

Market Risks Complicate Forward 1031 Exchanges

Regular or Forward 1031 Exchanges mean that investors sell his or her relinquished property first and then they have 45 calendar days to identify their replacement property and an additional 135 calendar days to acquire and close on the replacement property for a total of 180 calendar days for the entire 1031 Exchange.  The problem is that when a sale of relinquished property closes the depreciation recapture and capital gain tax liabilities are recognized.  Investors must identify and subsequently acquire and close on their identified replacement property acquisitions in order to defer the payment of these taxable gains.  If they can't then their 1031 Exchange fails and they must realize their depreciation recapture and capital gain taxes.

Reverse Exchange Helps Minimize Market Risks

This market risk exposes investor to potentially failed 1031 Exchanges, and explains why Reverse 1031 Exchanges have become so popular over the past 12 months or so.  The Reverse Exchange gives an investor the ability to take all the time they want to locate and acquire suitable replacement property, including doing their due diligence, before they sell their relinquished property.  The market risks involved in a Forward 1031 Exchange (i.e. identifying property within 45 days and completing the exchange within 180 days) because they actually acquire and close on their replacement property first so there is no risk that they will not be able to located, identify and acquire the replacement proeprty within the deadlines.

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