Can I do a 1031 exchange on my balloon payoff from Contract for Deed?

Question

I am considering selling a property via owner financing and want to understand the tax implications pros and cons. Please share any pointers including the obvious ones as I am new to this.

Also is there some way to do a 1031 Exchange on the balloon payoff (5 or 7 year term)?

The rental was purchased in 2020 and is free and clear. It is an investment property and never owner occupied.

Bill Exeter · Answer

You can do a 1031 Exchange at the time of sale with the seller carry back note, but can't do it when the note pays off.  The note payoff is just a pay down or pay off of debt and is not considered a sale of real estate at that point.  The actual sale of the real property occurs upfront and the "net proceeds" from the sale of the real property includes not only the cash but the seller carry back note.  The entire amount of "net proceeds" must be used toward the purchase of replacement properties to defer the payment of all your taxes. I would search for "1031 Exchange and Seller Carry Back Notes" to get much more information on the topic.

Celia Moore · Answer

Hi Jo! The short answer is no. In a contract for deed, the “sale” occurred when the contract began, not when it is paid off. Therefore, you cannot do a 1031 exchange for a balloon payoff on a sale that already occurred. Hope that helps!