Payoff loan prior to selling property in 1031 exchange

5 Replies

So I’m in a bit of a predicament. We are selling an existing rental property and want to do a 1031 exchange to avoid the tax consequences. One property that we are looking at to invest in as part of the 1031 exchange may not be certified for occupancy within the 180 day timeframe. That means we may have to pay cash for it for which we will take out a mortgage after the property is completed. The problem is it will have to be an all cash deal at first since nobody will lend on an incomplete property, but there is currently a loan on the property being sold. Can I pay off the loan on the sale of the current property before escrow closes so that I avoid having to take out a loan on the new property?

Yes you can but that Forces you to use the additional cash from the sale.  I’m not sure how paying off th loan would help....just use that money instead toward the all cash purchase.  You can bring additional cash to the table to purchase the replacement property, you’re not limited to the cash generated from the sale of the current property.

Thanks very much for the reply Wayne. The problem I have is there is a good chance the certificate of occupancy won’t be issued in the 180 day time period. I may have to go under contract and purchase the property before the certificate of occupancy is issued and it is my understanding that banks won’t lend on an uncompleted project.  So then I’d have to pay cash without a loan.  Don’t 1031 exchanges require not only that the replacement property cost as much as the sold asset AND the loan be as much as the loan on the sold asset?  If that’s the case, then I would be in violation of the 1031 exchange rules, no?

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Originally posted by @Kevin Kershisnik :

Thanks very much for the reply Wayne. The problem I have is there is a good chance the certificate of occupancy won’t be issued in the 180 day time period. I may have to go under contract and purchase the property before the certificate of occupancy is issued and it is my understanding that banks won’t lend on an uncompleted project.  So then I’d have to pay cash without a loan.  Don’t 1031 exchanges require not only that the replacement property cost as much as the sold asset AND the loan be as much as the loan on the sold asset?  If that’s the case, then I would be in violation of the 1031 exchange rules, no?

No, the two basic rules are....

1) you must use all the cash received from the sale of the sold property

2) the replacement property purchase price must be greater than the selling price of the sold property (less actual closing/selling costs)

That’s it...

You can bring additional cash and have no loan at all if you want, to buy the replacement property.

If the Only cash you used for the purchase was that received from the sale of the first property (which is what most people try to do) then by default you’d need a new loan for the property you purchase at least equal to your old loan (for an equal purchase price) but you don’t have to do it that way.

Thanks for the shout out @Brian G. . @Kevin Kershisnik , You technically don't have to replace debt for debt in a 1031.  In order to satisfy the requirements you must purchase at least as much as your net sale.  And you must use all of the proceeds in the purchase.  Paying off the loan before selling will simply mean that you have more proceeds that you have to use in your purchase (actually your net sale will equal your proceeds).  And that is fine.  But you don't have to.  You can add money to your proceeds at any time for your purchase.

So if you want to keep flexibility dont pay the loan off early.  Let the settlement do that.  Then if you end up needing to purchase that property for cash you can always add those outside proceeds to the 1031 proceeds at that time.

You're absolutely right about lenders not lending without a CO.  This is a common new construction problem.  Kudos to you for taking steps early to mitigate that.  It's a good plan.