I'm hoping to get some advice from you BP members who are experienced with 1031 Exchanges.
I just made an offer on an 80 unit apartment building. I will be assuming the existing mortgage on the property, and plan to pay the current owner $4,000,000, above the assumption, to sell to us. (The assumable mortgage is held by different investor than the seller)
I will pay the seller $2,000 payments each month over a 2 year period with a balloon payment at the end of that term. The idea is that this will allow me to stabilize the property in year 1 without draining all monthly cash flow.
The owner is interested in doing this, but there is a hitch. He would like to take the $400,000 and use it in a 1031 to purchase a larger property. He's okay with waiting until the end of the two-year term to receive the balloon, but not sure how that will affect his ability to use a 1031 Exchange.
- If he accepts the monthly payments, will the 1031 clock begin at closing?
- If so, is there any way for us to take title/ownership and still allow the seller to defer the 1031 clock until the balloon payment is received?
- If not, what other options would you suggest?
Thanks, in advance, for your help.
@Todd Keith , Conveyance of title will trigger the recognition of gain. And he's going to need to exchange more than just the down payment in order to have any kind of meaningful tax deferral.
One option would be to structure it as a lease/option. Have a substantial option fee and higher rent. But maybe structure it so that some or all of the rent and option fee are credited to purchase if exercised. If you're atty puts it together right you'll get the same effect - low cash outlay while stabilizing. And the seller can delay the start of his 1031 until he can do a complete 1031.
@Dave Foster - Good advice. Thank you!
So we would lease it from him with the option to buy at the end of the two year period. Our rent would be the $2K/month and the exercised option payment at the end of two years would be the remaining $352,000. Am I understanding that correctly?
If we took the lease option route, the seller would still be the owner of the property over that two year period. Is that correct?
Yep. There is also a legal concept called "risk of loss" that you want to be mindful of. A land contract or even a lease purchase might be interpreted by the IRS to be an actual sale if the terms are such that
risk of any loss to the property has passed from the seller to you. So keeping a separate lease and option agreement with arms length industry normal terms are what you'll want the attorney to draft up.
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