Liability and Insurance Coverage in Reverse and Improvement 1031 Exchanges

When completing a Reverse 1031 Exchange or an Improvement (Build-to-Suit) 1031 Exchange, investors must comply with IRS rules that require an Exchange Accommodation Titleholder (EAT) to temporarily hold, or “park,” legal title to the property. To facilitate this, a special purpose entity (SPE) is often formed, typically structured as a single-member limited liability company (SMLLC) treated as a disregarded entity for tax purposes.

The SPE serves solely to hold title to either the relinquished property (in a Reverse Exchange) or the replacement property (in an Improvement Exchange) during the transaction period. While the SPE is the titleholder, insurance coverage becomes a critical part of risk management.

Insurable Interest

Because the SPE is listed on legal title, it has an insurable interest in the parked property. This exposes the entity, and by extension the EAT, to potential liability. For this reason, insurance must be in place before the EAT will acquire and hold legal title.

Typically:

• The SPE and the EAT must be named as insureds.

• The investor should also be listed as an additional insured, since they maintain an ownership interest in the exchange.

• Evidence of insurance, such as an insurance binder, must usually be reviewed and approved before closing.

Types of Required Insurance Coverage

The amount and type of insurance coverage required depends on the nature of the property and the specific risks of the transaction. However, general industry guidelines often include:

1. Property and Casualty Insurance

Covers the replacement cost of the parked property. Deductibles should remain within reasonable and prudent limits.

2. General Liability Insurance

Protects against claims for death, bodily injury, or property damage resulting from the use or occupancy of the property.

• Minimum coverage levels often include:

  • $500,000 for single-family residences, condominiums, or duplexes

  • $1,000,000 for multi-family properties

  • $2,000,000 for commercial, industrial, retail, office, or land valued under $5 million

  • $5,000,000 for larger or higher-value commercial properties

3. Course of Construction Insurance

Also known as builder’s risk insurance, this must be in place before any improvements or construction begin on the property. Coverage amounts are based on the scope of the planned work.

4. Workers’ Compensation Insurance

Required before any developer, contractor, or service provider begins work on the property. This protects against injuries sustained by workers during construction or improvements.

Primary vs. Excess Coverage

Insurance policies used in 1031 Exchange transactions should be designated as primary coverage, with any other existing policies treated as excess. This ensures that the SPE and EAT are fully protected while holding title.

In both Reverse and Improvement 1031 Exchanges, proper insurance coverage is not optional — it is a structural necessity. Forming a special purpose entity to hold title shifts liability, and adequate insurance ensures that all parties (investor, EAT, and SPE) are protected during the exchange period.

Because requirements can vary depending on property type, value, and planned improvements, investors should always consult with experienced tax, legal, and insurance professionals to ensure compliance and risk mitigation.