REVERSE 1031 exchange w an escrow agreement - intermediary?

Question

Need help BP peeps! Have a customer that has done a REVERSE 1031 exchange. They identified and purchased a property during last quarter of 2020. They have now went under contract with one of their rentals to complete the 1031. However, it is an escrow agreement with buyer paying 30k down and annual payments of 25K over next four years. Attorney handling Reverse 1031 exchange is questioning it with the second part being purchased by escrow agreement.

Does intermediary hold the money until it is paid off and deed exchanged or does intermediary pay the identified property with each installment? Is it a simple pass through for the intermediary?

Kyle Hood

Mike B. · Answer

@Dave Foster

Dave is the man

Kyle Hood · Answer

Thanks Dave for the info! Very informative and will pass it on. Fortunately, this wasn’t a big exchange so believe chalking it up as a learning experience.

Dave Foster · Answer

@Kyle Hood,  Your client is in a pickle   Its the QI's job to know how to handle this.  What worries me is if that attorney has even followed Rev Proc 2000-37 and set up the reverse correctly.  The client did not actually take title to the property did they?  In a safe harbor reverse they should have known that your client has 180 days from the day the attorney took title to the new property to complete the sale of their old property.  The attorney cannot wait until all payments have been received.  The exchange will fail on day 181 after the purchase of the new property.

If the attorney has structured outside the safe harbor ( a whole nuther can of worms) it does not change the timing windows of the relinquished side.  The client has 180 days from the date of their sale to complete their purchases.

So either way the owner carry financing is a wrinkle that attorney should have addressed.

Tell the attorney that the client has 180 days from the date of the sale to complete the purchase.  And if your client sells and carries back owner financing then there is a very particular way it has to be handled if they want to avoid a huge boot issue.

In order to get full tax deferral the down payment and the note have to go into the exchange account.  The note has to become assigned to the QI.  The client has to replace the note with cash of their own equal to the amount of the note.  Then once that happens the client now has enough cash in their account to complete the 1031 exchange and outside the 1031 they receive the note now in their name .  All of the tax is deferred and the only tax left on the note is on the interest portion of the payments.

The other option would be for the client to exclude the note from the 1031 exchange.  Tax will be deferred until payments come in but the client will still pay the tax.  Unfortunately if the down payment is only $30K then I highly doubt there are any tax savings left after paying tax on the note.  So there is no reason to complete the exchange.  And no reason to have started the reverse in the first place :(

Bill B. · Answer

Are you sure that’s even going to qualify? Your seller might be able to pop in his own cash to buy out the note? Which is what you really have from his buyer.

You’re going to need a BP 1031 expert. Hopefully one will chime in because it’s an interesting question. Even if I assume I’ll never see it personally.

Wayne Brooks · Answer

That doesn’t sound like it will qualify, particularly if he’s not using all his cash now. @Dave Foster??

Steve Morris · Answer

Call up a QI, but kinda sounds like you're shaky.  Think the QI controls the up-leg until you sell the down-leg.

LESSON - BEFORE you do any transaction, get with someone that knows what they're doing like a QI

Then again, I see these <1% of the time, since most people need to sell something first to pay for the replacement.

Kyle Hood · Answer

There is a qualified intermediary but left some of this up in the air, Bill Exeter helped me out and answered the question.  Hopefully my summary is correct.  Basically, if the equity is greater in the one purchased then the one sold then everything should be fine.

REVERSE 1031 exchange w an escrow agreement - intermediary?

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