1031 Exchange & Seller Financing

[Alexander F Pollock]

Has anybody done seller financing with a property that was a 1031 exchange? I'm looking at a triplex that the owner has had since 2003 and was part of a 1031 exchange. They tried selling last year but couldn't find anything to buy. I really like this property because I can use the downstairs offices as a studio to teach music from, there are 2 apartments upstairs, and it's less than a mile down the street from where I live. I can offer the seller flexibility since I'd be willing to wait and understand the constraints of a 1031 exchange. I did find this blog about how there are two ways to do a 1031 exchange with seller financing but figured I'd see if anyone had any thoughts.

https://www.accruit.com/blog/s...

Thanks

[Bill Brandt]

The only way the seller can offer you financing if they plan to do another 1031 is replacing all the cash they finance for you with cash from their own pocket in additional funds. 

So if you were buying a $400k property with a $200k loan and $200k in seller financing. The seller would have to buy something over $400k and put in $200k in cash from their own pocket, not additional financing. Their major downside is you not having at least $50-$100k of your own cash invested means they really got nothing and would lose their behinds if you failed to make payments…(assuming no realtors involved, otherwise they need $100k+ of your money Just to be even on current sales costs and future re-sale costs)

[Steve Vaughan]

I sold with SF as a way off the wheel.  Your seller ran a while and gave up.  

If I was older I would've kept running on 1031s so my heirs could inherit stepped-up.

if your seller isn't ancient, SF is a way out that at least spreads the tax hit out nicely. Let them know you can let them off the wheel.  

[Marco Bario]

@Alexander F Pollock -

The seller could would achieve some tax advantage by using an installment sale (IRS name for seller financing) without a 1031 exchange. 

Installment sales allow the seller to distribute capital gains over many years rather than recognizing the gain in a single tax year.  

The seller is only taxed on the portion of capital gain received in each specific calendar year, and may allow them to remain in a lower tax bracket. 

See IRS Publication 537 for more information. 

[Jared Prevost]

Hi @Alexander F Pollock

If a seller is looking to 1031 there really isn't much sense in seller finance and it doesn't really work either. They are two different exit strategies that don't work together.

If the numbers don't crunch with traditional financing, your best bet is likely spending your time looking for a better deal

[Dave Foster]

@Alexander F Pollock,  The seller can simply use seller financing and spread the gain and tax out over the years.  Or They can combine with a 1031 exchange.  If they have cash resources to replace the note in the exchange account.  Combining 1031 with owner financing is actually pretty slick as it creates tax free cash flow and still keeps the current tax deferred in the 1031.

Another option you might want to explore is a lease/option.  Their hang up is that they couldn't find a good replacement.  Lease the property from them until they find a good replacement.  then exercise your option and buy the property so they can do a 1031 into their new property they've identified.

[Wale Lawal]

@Alexander F Pollock

In a sale of real estate, it’s common for the seller, the taxpayer in a 1031 exchange, to receive money down from the buyer in the sale and to carry a note for the additional sum due. The taxpayer facilitates financing for the buyer in this way to make the transaction happen. Sometimes this arrangement is entered into because both parties wish to close, but the buyer’s conventional financing is taking more time than expected. If the buyer can procure the financing from the institutional lender before the taxpayer closes on their replacement property, the note may simply be substituted for cash from the buyer’s loan. Regardless of the circumstance for seller financing, without further steps, the taxpayer’s use of the value of the note toward the purchase of the replacement property will be taxable.

Good luck!

[Alex Olson]

@Alexander F Pollock I have been able to help clients successfully complete a seller finance sale AND complete a 1031 exchange. It requires you, the buyer, to lease the property from the seller (seller maintains title) for certain period of time and then when you close (and take title years later) the seller would find their replacement property. This is a win win for everyone. Seller keeps title and money and doesn't have to find replacement property. Buyer gets to control property with less money than would be required when financing through a bank. The ONLY way that this works is a)buyer and seller must have 100% trust in each other b)seller gets what he/she wants (likely their asking purchase price). c) Buyer get's to put less down than would be required by a bank. If you are expecting to get a discount off the price and seller financing you are VERY unlikely to succeed. Of course, you need to have a good attorney as well. Hope that helps!

[Jared Prevost]

@Alex Olson Would this essentially be selling on a land contract? Then once the note is due or the buyer does a refi, the seller must start the 1031 process - or are you talking about buying doing a lease option/master lease?

[Dave Foster]

@Jared Prevost, This is a very tight rope to walk.  With a true land contract the 1031 must start with the signing of the contract (very difficult with a 1031.  Because the burdens and benefits of ownership of the real estate transfer with the signing of the contract not the transfer of deed.

A lease with an option to purchase is much easier.  The buyer simply leases the property until the seller is ready to sell.  This way burdens and benefits of ownership of the real estate transfer with the transfer of deed.  And money usually passes at that time as well.  So it's easier to 1031.

[Alex Olson]

Quote from @Jared Prevost:

@Alex Olson Would this essentially be selling on a land contract? Then once the note is due or the buyer does a refi, the seller must start the 1031 process - or are you talking about buying doing a lease option/master lease?

 Master lease.