There are four main types of 1031 exchanges investors can choose from, which include the simultaneous, delayed, reverse, and construction or improvement exchange. Continue reading to learn the details of all 4 of these 1031 exchange types.
The 4 Types of 1031 Exchanges Explained
Delayed Exchange (The Most Common Type)
The delayed like-kind exchange, which is by far the most common type of 1031 exchange chosen by investors today, occurs when the exchangor relinquishes the original property before he acquires the replacement property.
In other words, the property the Exchangor owns (which is called the “relinquished” property) is transferred first and the property the Exchangor wishes to exchange it for (the “replacement” property) is acquired second.
The Exchangor is responsible for marketing his property, securing a buyer, and executing a sale and purchase agreement before the delayed exchange can be initiated. Once this has occurred, the Exchangor must hire a third-party Exchange Intermediary to initiate the sale of the relinquished property and hold the proceeds from the sale in a binding trust for up to 180 days while the seller acquires a like-kind property.
Using this strategy, an investor has a maximum of 45 days to identify the replacement property and 180 days to complete the sale of their property. In addition to the numerous tax benefits, this extended timeframe is one of the reasons that the delayed exchange is so popular.
Simultaneous 1031 Exchange
The second type of 1031 exchange is called a simultaneous exchange. This type of exchange occurs when the replacement property and relinquished property close on the same day. As the name suggests, these closings occur in a simultaneous fashion.
It is important to note that the exchange must occur simultaneously; any delay, even a short delay caused by wiring money to an excro company, can result in the disqualification of the exchange and the immediate application of full taxes.
There are three basic ways that a simultaneous exchange can occur.
- Swap or complete a two-party trade, whereby the two parties exchange or “swap” deeds.
- Three-party exchange where an “accommodating party” is used to facilitate the transaction in a simultaneous fashion for the exchanger.
- Simultaneous exchange with a qualified intermediary who structures the entire exchange.
A reverse 1031 exchange, also known as a forward exchange, occurs when you acquire a replacement property through an exchange accommodation titleholder before you exchange the property you currently own. In theory, this type of exchange is very simple: you buy first and you exchange later.
What makes reverse exchanges tricky is that they require all cash. Additionally, many banks won’t offer loans for reverse exchanges. Taxpayers must also decide which of their investment properties are going to be acquired and which will be “parked.” A failure to close on the relinquished property during the established 180 day period that the acquired property is parked will result in a forfeit of the exchange.
This type of 1031 exchange follows many of the same rules as the delayed exchange. However, there are a few key differences to note:
- Taxpayers have 45 days to identify what property is going to be sold as “the relinquished property.”
- After the initial 45 days, taxpayers have 135 days to complete the sale of the identified property and close out the reverse 1031 exchange with the purchase of the replacement property
Construction or Improvement Exchange
The final type of 1031 exchange we’re going to highlight is the construction exchange. This type of exchange allows taxpayers to make improvements on the replacement property by using the exchange equity. To put this into layman’s terms, the taxpayer can use their tax-deferred dollars to enhance the replacement property while it is placed in the hands of a qualified intermediary for the remainder of the 180 day period.
It is important to note that the taxpayer must also meet three requirements if they want to defer all of the gain (from the sale of the relinquished property) and instead use it as part of the construction or improvement exchange.
- The entire exchange equity must be spent on completed improvements or as a down payment by the 180th day.
- The taxpayer must receive “substantially the same property” that they identified by the 45th day.
- The replacement property must be equal or greater in value when it is deeded back to the taxpayer. The improvements must be in place before the taxpayer can take the title back from the qualified intermediary.