Reverse 1031 Exchange

[Ashish G.]

Folks,

I am looking for anyone who has done a reverse 1031. In this you buy the new property first, it is held under a SMLLC title by 1031 intermediary and then you sell the existing property. 

This eliminates the risk of not being able to find the new property after selling your old one and then end up paying capital gains. 

If you did a reverse 1031, how was experience overall? Did you had issues with mortgage lenders raising concerns about holding title of new property in SMLLC until 1031 completes?

Thanks

[Dave Foster]

@Ashish G., I can give you some QI perspective if that's helpful.  The two biggest hurdles in a reverse exchange are swallowing the extra cost and the financing.  The cost is what it is.  Reverse exchanges are just quite a bit more complicated.  and in your state it's even worse as the Franchise tax board has shown quite a bit of dislike and aggression to reverse exchanges.  

The financing will trip anyone up who is looking for conventional financing.  The normal lender using federal financing guidelines and sells the loan on the open market cannot underwrite these loans.  The loan is made non-recourse to the holding entity with the down payment from you and guaratneed by you.  But you are not a member of the holding entity.

There are plenty of lenders however. Portfolio banks and credit unions, private lenders, a ton of IRA lenders are all good sources.

Honestly, I would venture to say that maybe 40% of the reverses we do could be handled as just regular exchanges with a little more foresight and planning on the part of the client.  There are many ways to mitigate the  angst of the 45 day identification period including:

1. Using contingencies as seller or buyer

2. Going into contract for your purchases before closing your sale

3. Using escalating earnest money (maybe even released earnest money) to the seller can convince them to wait for you.

4. Put passive back up properties that are passive like DSTs in case you can't find a good replacement

5. Be ready to let your exchange die rather than buy a bad property.  Remember you're only paying tax on the profit.  And no one ever went broke paying tax on profit.

Where I'm seeing the greatest application of reverse exchanges now would be what we call improvement exchanges.  In an improvement exchange you may be selling a property for $500K and want to buy a $300K property that needs $200K in improvements.  You would start a reverse exchange and the QI takes title to the new property while it's being improved.  Then you can sell your old property for $500K (if done before we take title to the new property you can use your exchange proceeds to do the reverse) and buy the new improved property from the QI for $500K.  That is a powerful application for today's market that's well worth exploring given shrinking margins on purchased investments.