All Forum Posts by: Bill Exeter

The widespread belief is that seller financing and 1031 Exchanges cannot be used together. This is not true. Seller carry-back financing and 1031 Exchanges are often used in combination with each other. However, using them together is considerably more complex and requires careful planning and organization to ensure a smooth and successful 1031 Exchange transaction.

There are really five (5) options to consider when trying to structure the sale of investment real estate with a seller carry back note and a 1031 Exchange together. 

1.  Lender.  You put out-of-pocket cash into the closing to "fund" the seller carry back note. You are effectively acting as the lender.  The seller carry back note is drafted in your name as lender.

2.  Funding Note Inside 1031 Exchange.  You can raise the cash needed to fund the seller carry back note, but you need some time to do so. The seller carry back note would be drafted in the name of the Qualified Intermediary FBO "you." The sale closes and the Qualified Intermediary now holds the net proceeds (cash plus seller carry back note).  Later, you (preferably an affiliate of the Exchangor) raises the cash and deposits the cash into your 1031 Exchange account (before you need to close on the replacement property). Your affiliate is effectively buying the note out of your 1031 Exchange account so that you have all cash for the purchase of your replacement property.

3.  Sell the Note.  You can't come up with the out-of-pocket cash. The seller carry back note would be drafted in the name of your Qualified Intermediary and then you would arrange to sell the seller carry back note to convert the note to cash so that you can proceed with your replacement property purchase.

4.  Use Note as Consideration.  You can't come up with the out-of-pocket cash. The seller carry back note would be drafted in the name of your Qualified Intermediary. You locate replacement property and assign/endorse the seller carry back note to the seller of the replacement property as part of the payment/consideration for the purchase of the replacement property.

5.  Give Up.  You give up and the seller carry back note is drafted in your name (outside of the 1031 Exchange) and is taxable as an installment note under Section 453 of the Internal Revenue Code.

And, there you go.  So, contrary to what you hear or read, you can combine a seller carry back note with a 1031 Exchange, but it gets complicated.  The best advice when you are planning to do a 1031 Exchange is to avoid seller carry back notes.  They are very beneficial for the buyer while the seller assumes all of the risks. 

Generally, selling to a related party (which is not what you are doing) will work.  There is just a two year holding period.  However, buying from a related party in most cases will not work. Revenue Ruling 2002-83 is the specific ruling that covers related party transactions.  Essentially, Revenue Ruling 2002-83 is trying to prevent the avoidance of tax by related party transactions.  As Dave points out, it is not prohibited by statute, but your tax advisor should review Revenue Ruling 2002-83 to ensure that you do not run afoul.  My educated guess, based on the limited information provided, is that it would not work in your case, but there a few exceptions. 

Good morning @Dave Foster, yes we do foreign property 1031 Exchanges.  Foreign property 1031 Exchanges are more complicated due to the local laws, regulations, closing customs, etc.  There are also foreign currency issues.  It is important that the QI is able to accept and hold the 1031 Exchange funds in the foreign currency and not convert to U.S. Dollars (unless needed) to prevent foreign currency risk.  

Hi Patricia, 

Contrary to what you read, foreign properties do qualify for 1031 Exchange treatment.  However, the relinquished property and the replacement property must all be foreign property.  The sale of your Dominican Republic property and the purchase of a replacement property in the US would not be considered like-kind property for 1031 Exchange purposes. 

Hi Nikola, 

You mention that you inherited the property.  Have you discussed the 1031 Exchange with your tax advisor?  You may not need to do a 1031 Exchange if you received a step-up in cost basis.  So, first thing is to determine if you need to do one.  

They are likely referring to a Reverse 1031 Exchange.  The new replacement property can be acquired (closed) before they close on the sale of their relinquished property. However, the IRS requires a "parking arrangement" to be put into place.  Legal title to either the relinquished property or the replacement property must be acquired and held or "parked" by an Exchange Accommodation Titleholder (generally an affiliate of the Qualified Intermediary.  The structure is outlined in IRS Revenue Procedure 2000-37. 

Bill is right on the money.  The loan has nothing to do with profit or taxable gain or what you must reinvest.  It is just part of the "capital deck" in terms of how you financed the property.  

The reinvestment must meet two requirements to qualify for 100% tax-deferred exchange treatment.  You must trade equal or up in value based on your Net Sale Price (Gross Sale Price less certain routine selling expenses), so about $570K in your example, and you must reinvest all of your cash equity that comes out of the sale of your relinquished property.  

You can structure an Improvement 1031 Exchange where the Qualified Intermediary acquires and holds or "parks" legal title to the replacement property while you make the intent improvements to the replacement property within the 180 calendar day exchange period. The costs to acquire the property and the costs of the improvements will determine the amount that you have reinvested. The ARV has nothing to do with the 1031 Exchange reinvestment computation.

You can certainly "trade down" in value, but the amount that you do not reinvest will be taxable.  For example, if you sell for $600K, subtract $30K in routine selling expenses, and only reinvest $300K, you have traded down by $270K ($600K less $30K less $300K) and the $270K would be taxable (unless offset by something else). 

You are most welcome.