This lesser-known tax strategy is giving some buyers an edge in competitive housing markets

Tax strategies can be complex, but Lisa Villarreal, a strategist at First American Exchange Company, said one lesser-known option — the Reverse 1031 Exchange — can help real estate investors defer capital gains taxes.

Unlike a standard Like-Kind 1031 Exchange, where investors sell a property before buying another, a Reverse 1031 allows them to purchase the replacement property first. The IRS-approved strategy is especially useful in competitive markets, giving buyers time to secure the property they want without being rushed to sell.

To qualify, the replacement property must be worth as much as or more than the one sold, Villarreal said. 

A third-party entity, called an exchange accommodation titleholder (EAT), temporarily holds title to one of the properties, while a qualified intermediary manages the funds to ensure sellers never take direct possession. Investors then have 45 days to identify the property they’ll sell and 180 days to close the deal.

The benefits

This approach is especially useful in hot markets, where buyers want to lock in a desirable property before their current one sells.

 “It’s an option for (homebuyers) who don’t want to worry about timing and are interested in making sure they get the property they want,” Villarreal said. It can also help when sales are delayed by tenant issues or time needed to prepare the property for sale.  

The downside

The trade-off: Reverse exchanges are more complex and costly. Financing can be difficult since some lenders are reluctant to work with interim entities, often leading to higher-interest loans, she said. There are also added fees and the potential for property tax reassessment due to multiple deed transfers.

Combined tax strategies

Villarreal said buyers also can combine tax strategies, such as pairing a Section 121 exclusion (for a primary residence) with a 1031 exchange. In this approach, a homeowner converts their residence to a rental for at least two years, then sells within three years to keep the 121 exemption while also using the 1031 benefits.

Silicon Valley Association of Realtors (SILVAR) is a professional trade organization representing 5,000 Realtors and affiliate members engaged in the real estate business on the Peninsula and in the South Bay. SILVAR promotes the highest ethical standards of real estate practice, serves as an advocate for homeownership and homeowners, and represents the interests of property owners in Silicon Valley.

The term Realtor is a registered collective membership mark which identifies a real estate professional who is a member of the National Association of Realtors and who subscribes to its strict Code of Ethics.

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