What You Need to Know About the 4 Types of 1031 Exchanges

Deciding to move forward with the exciting opportunity of a real estate investment using a 1031 exchange is intriguing but you need to understand the 4 key types of exchanges before moving forward. These are a simultaneous exchange, a reverse exchange, a delayed exchange and an improvement exchange. Read on to learn more about these.

A simultaneous exchange refers to situations where the relinquished property and the closing of the replacement property happen on the same day usually happening one right after the other. There is no time that elapses between the two closings and this exchange is covered by Safe Harbor Regulations. Although a simultaneous exchange is rare, it is possible that you could relinquish one property and replace it with another on the very same day.

In a reverse exchange, the replacement property is purchased and closed on before the initial property is sold. You will need a qualified intermediary to take the title for the replacement property and hold it until you as the taxpayer can find a buyer for the relinquished property and closed on that sale using an exchange agreement with the qualified intermediary. Once the closing has happened on the relinquished property the qualified intermediary conveys the title to the replacement property to the taxpayer. The IRS does have Safe Harbor Guidance and recommendations for reverse exchanges.

In a delayed exchange the replacement property is acquired at a later date than the closing on the sale of the relinquished property. This exchange is therefore not simultaneous and it does not happen on the same day. Sometimes this might be referred to as a Starker Exchange named after the famous Supreme Court case that ruled in the taxpayer's favor on a delayed exchange issue. There are clear timelines established by the Internal Revenue Service Code and Regulations for completions of a delayed exchange. Most importantly being the 45 days in which to identify a new property and the 180 day period in which you have to close on that property.

Finally you might decide to move forward with what is known as an improvement exchange. This is where a taxpayer wants to acquire a property and arrange for construction improvements on that property before it is moved into the status of replacement property. This usually happens with unimproved lots or a building but it might also include enhancements made to an already improved property in order to increase the value to close on the exchange without any boot.

The code and regulations established by the Internal Revenue Service do not take into account improvements made to a property after the closing has happened on the replacement property. This is why it's essential for the qualified intermediary to close on, take the title of and hold the title to this property until the improvements are constructed. At that point the qualified intermediary will then convey the title for the improved property to the taxpayer as replacement property. It depends on the circumstances but your improvement exchange could be handled as a delayed exchange or a reverse exchange.

As always make sure to hire the right qualified intermediaryry to handle your transaction so that you feel confident about your decision.