Is it a good to buy a property if sellers add a 1031 contingency?

12 Replies

My fiancé and I are looking to buy our first investment property, a duplex under and FHA loan. We recently through out an offer and the seller accepted with a contingency on a 1031. Our real estate agent has advised that it may not be a good idea to move forward on as it seems the seller will look to obtain the property back if unsuccessful finding another property within the time frame necessary for the 1031 tax laws. I'm still learning about the 1031 tax law and know if can provide benefits when selling a property and getting another. Is this something the seller could do? What is the downside if you are buying a property from another investor using the 1031 tax law for their benefit?

Your agent doesn’t understand fully the 1031 process.  The seller has 45 days to identify his replacement after he closes the sale to you.  If doesn’t fulfill his 1031 purchase of another property, he has Absolutely no way to “undo” his sale to you.....it is done and over.

Your agent  is misinformed and a bit paranoid.

I’m sure the “1031 addendum” (typically used on the purchase end of the 1031) says nothing about him being able to undo the sale should he not find a replacement property in time.

I think the seller has to write that into the contract for their own tax purposes.  They can’t take back the property after it is sold.  The seller has a specific time period to #1 - identify properties to purchase from 1031 sale, and #2 - purchase a property from that list.  This has nothing to do with your purchase of the property. 

Hope this helps. 

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@Wendy Lacey,  It does not sound like this is the routine 1031 notification that @Wayne Brooks is referencing.  He's absolutely right - a simple notification that the seller is doing a 1031 should not in any way inconvenience the buyer.

But the way you use the word contingency and what your realtor say make me think that this might be an actual contingency for either an extended closing date or closing only after they have found a suitable replacement.  Both Wayne and @James Herbold are correct.  Once the sale occurs there is no "taking back" the property.  But the contingency might be written such that the seller can cancel the contract if they don't find a good replacement.

This type of contingency is not uncommon.  It's also not anything to fear as long as you understand it.  Remember, they are asking for this in exchange for a discounted price.  So you're getting something you may not have.  Before I'd walk away it would certainly be worth it to explore is the contingency can still have a maximum time and then you still get to purchase.  Or you could ask for more money for that contingency.  

If you take a look at the entire picture - You're getting a discounted price to start with.  You may not have to close for a while but it will be under contract so you get all of the appreciation that happens between contract and closing.  If they do find a property they want and put it under contract they are now a motivated seller and there will be less of a chance of seller hijinks going toward closing.

@Wendy Lacey if in doubt, have an RE 1031 attorney review it. Sometimes it is well worth spending a little to understand it. You can always counter with different limitations if you want.

Unless your Realtor specializes in investment properties they may know less than you about 1031 law

@Sharon Rosendahl @Wayne Brooks @James Herbold @Dave Foster

Thank you all for your replies!! We truly appreciate your knowledge. I was able to take a look at the counter offer RE 1031 this morning and wanted to share additional info. 

They have added in writing "Subject to seller finding replacement property by way of 1031 exchange." Then under standards the contract language states "1031 Exchange: If either Seller of Buyer wish to enter into a like-kind exchange (either simultaneously with Closing or deferred) under Section 1031 of the IRS Code ("Exchange"), the other party shall cooperate in all reasonable respects to effectuate the Exchange, including execution of the documents; provided, however, cooperating party shall incur no liability or expense related to the Exchange, and Closing shall not be contingent upon, nor extended or delayed by, such Exchange." 

Our realtor noted to me that what they have put in the contract is ambiguous and contradicts the contract itself. She also notes that if the seller does not find another property and the sale does not go through, we may lose our EMD.

I also question this and hesitate thinking we will put down the EMD and pay for inspection appraisal and in the end never close because they didn't find a property to complete the Exchange.

She recommends if we move forward, it only be with that handwritten language removed.

@Wendy Lacey I was at a closing I was doing last week. This was my 10th real estate transaction..so I’m not a super experienced expert but I’m also not new.

Anyways, DURING closing the attorney informs me that the seller is doing a 1031 exchange. (Seller told the attorney that morning, the day of closing), and so I had to sign some extra paperwork regarding that.

My point is, the seller did this the day of closing, did not tell me, barely gave his attorney enough notice and we still closed on time.

It had zero impact on me. I still own the house, for better or for worse. I think you may want to find a new agent.

@Wendy Lacey Our clause was about cooperating. This could have caused a short delay but mostly it was an agreement that we didn't make buyer incur extra fees related to 1031 and that they would sign additional forms and actually sell to the intermediary etc. My understanding was that was the boilerplate. If you really want it get an attorney. You could counter with a standard 1031 clause. You can move on.

I don't think they can keep your earnest unless it is clearly stated they can or there is no verbiage stating you will get it back if seller cancels. Again, an attorney is in order.

@Wendy Lacey Again, your agent is off the mark in saying you’d lose your EM if the Seller doesn’t perform..

We don’t know Exacrly what the extra contingency says....if it is too cumbersome, simply deny the contingency, then the seller needs to fish or cut bait.  If you do agree to some sort of cancelation right to the seller, make sure you include payment to you for appraisal and whatever else.

@Wendy Lacey  I have done several 1031’s and never had an issue in either side of the deal.  In your circumstance I would counter with language that requires the seller to reimburse all costs related to your due diligence if he decides not close for any reason.  That puts added pressure in him to get his exchange property in order in a timely fashion, and it will tell you just how serious he is.  If he refuses that counter then I say it’s time to walk.  

@Wendy Lacey, I'm with @Wayne Brooks on this one.  The cooperation clause is specifically there to protect you from any harm or cost related to the other party doing a 1031.  I don't think your earnest money is at risk.

But..... inspection money???  Maybe - again not in the long run but you might have to sue to get it.  You'd win.  But who wants to file suit over an inspection???  You want to purchase real estate.  

The fact that the seller wants a floating closing date to find their own replacement property is really the biggest detriment to your contract.  It's too vague.  They could indeed decide that they can't find a property so won't sell.  I'd counter with a period of time followed by a definite closing date.  Or walk like your realtor is suggesting.

@Dave Foster I think based on the language, we will only move forward if they remove their contingency. We will see what happens - there are other moving parts for this as well. Just wanted to learn more about this in particular. Thanks again to everyone for their insight.