1031 exchange with seller financing

[Daniella Spears]

I'm planning on doing a 1031 exchange with a friend where we agreed he would put 10k down and I would do seller financing for 140k for five years at 10% until he is qualified for a mortgage therefore paying me the bulk of the purchase. It would be a 5 year contract. Would I have 180 days to find a property when he gets qualified for a loan or when we close agreeing to the seller financing agreement?

[Dave Foster]

@Daniella Spears, Your exchange starts with the closing of the sale.  So from a calendar point of view you have 45 days from that date to identify your potential replacements and 180 from that date to close.  The trigger is not when he gets a mortgage it is when the property is sold.  

But here's the real issue you'll face:  Given that the 1031 would have to start when you deliver title to him you also have to consider that in doing the 1031 you must use all of the proceeds to purchase your replacement property and you must purchase at least as much as you sell.  So that means that you would have to use both the 10k and the note for 140k to purchase a property worth at least $150K

The note will be difficult to use without selling it some way.  So the way most people make a 1031 work in a situation like this is to replace the note in their exchange account with cash of their own.  When you do this your exchange account has $150K and you can complete your 1031 without a problem.  But you've got to find access to that cash somewhow.

So it's doable but not without complications.  And your timelines start with the closing of the sale.

One suggestion would be to rent the property to him with an option to purchase it. When done right this doesn't trigger a deemed sale.  So your 1031 can wait until he has restored his ability to get a mortgage.  And he still gets use of the property while he does that.

Then in the 5 years or whatever he exercises the option and purchases the property.  And you then do a 1031.