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Owner carry -- how to avoid boot -- and not blow up the exchange
Can anyone with experience doing an owner carry with a 1031 exchange verify the following?
Do I need to use all my equity, plus the cash I bring to close, and put all of it into the replacement property?
As a simple example, say I'm selling a property for $600k with a $200k loan balance. Buyer gets a $200k owner carry loan. If I bring $200k to closing to fund the owner carry, do I get that $200k back or do I just get the prom note? And then do I have to put all the equity ($400k) into the replacement property thru the 1031 exchange? Or does only $200k have to go into the replacement property?
Better strategies for your 1031 exchange
These strategies are presented in the order which we prefer. In each case, consider a scenario where your buyer is asking for $200,000 of seller carry financing to close the deal:
1. You bring cash to make up the difference
If financially able, you substitute new cash financing for the owner-carried note. That new cash — now a lump-sum and not coming as installments — goes into your 1031x escrow account. In effect, you cover the difference ($200,000) that the buyer is asking for, which allows you to show the IRS that 100% of the money in the sale went directly through your escrow account and toward the purchase of valid 1031x replacement property.
Acting as the lender, you now bring the full amount of cash (the face value of the note) to the closing table. A promissory note and deed of trust would be executed between you and the buyer.
Again, now the full balance of the 1031 exchange is immediately available after the sale and is ready to be used for the replacement property purchase. This strategy is doubly beneficial:
- The 1031x is completed in an entirely tax-deferred way (including deferral of recaptured depreciation).
- The tax basis in the note is now its face amount instead of a carried over basis from the relinquished property. This is the best/easiest option for completing the 1031 exchange, but it requires that you have the financial means available!