Reverse 1031 exchange possible but can be tricky and expensive
Tribune Content Agency Q:
I am a real estate agent in New York City. I have a client who lives out of state but owns a second home here in New York, which is a co-operative apartment. The apartment is subleased and is an investment property for her.
She is interested in buying a second investment property in the city prior to selling her currently owned investment property. Is it possible for her to close on the purchase of her second home prior to selling her first investment property and still take advantage of the like-kind exchange rule preventing her from paying capital gains taxes? If so, how does she do this? A:
Traditionally, a like-kind exchange of real estate -- also known as a 1031 exchange -works like this: A seller closes on the sale of an investment property and deposits the proceeds in a qualified exchange with a company that specializes in 1031 exchanges. Then, following specific rules, the person designates a replacement property within 45 days of that sale and closes on the new property within 180 days of the first closing. There are quite a few other rules that go along with that summary but you get the sense that you sell first and buy later.
However, you can also do it the other way, but it can be quite expensive and may not work in your situation. In a delayed exchange or reverse exchange, you buy the new property first, but the property isn’t purchased by you but rather by the exchange company. Then when you have the old property sold, you proceed to exchange new property for the old one.
Here are some pitfalls we see in your situation. When you own a co-op apartment, the board wants to know exactly who will own the apartment. In the reverse exchange situation, an intermediary company would be the buyer. The coop board may not go along with this arrangement. Also, you have to keep in mind that you have extensive additional transaction and closing costs in this arrangement. Those costs could outweigh the benefits of trying to get the transaction done.
Try talking with the seller of the property your client wants to buy and see if you can work out an arrangement to delay that closing until the existing unit is closed. Your client may have to put down a substantial down payment that could be forfeited if she fails to close on the purchase.
Another option is to set the sales price of the currently owned co-op unit aggressively enough that it sells quickly and work with the co-op board to get the deal closed as soon as possible.
We recommend that you talk to a 1031 exchange company that can walk you through the exact details of the cost of a traditional exchange and then give you the costs of a reverse or delayed exchange. When asking about the company’s fees, get specific details about additional transaction costs you’ll incur, including legal, recording and filing fees, document preparation fees, and any other additional lender fees and expenses.
(Ilyce Glink is the creator of an 18-part webinar and ebook series called “The Intentional Investor: How to be wildly successful in real estate,” as well as the author of many books on real estate. She also hosts the “Real Estate Minute,” on her YouTube. com/expertrealestatetips channel. If you have questions, you can call her radio show toll-free (800972-8255) any Sunday, from 11a-1p EST. Contact Ilyce and Sam through her website, www.thinkglink. com.)
(c) 2014 Ilyce R. Glink and Samuel J. Tamkin. Distributed by Tribune Content Agency, LLC.