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Real estate investors often need to think outside of the box and look for creative solutions when trying to sell 1031 investment property

, especially in challenging real estate markets. Prospective buyers may have difficultly in obtaining financing for the purchase of 1031 investments. The real estate seller may need to step forward and help with the financing in order to complete the sale of the investment property.

Seller Carry Back Financing

One creative solution is using a seller carry back note or seller financing to help structure the sale of the 1031 exchange relinquished property. The real estate seller functions as a lender by lending money to the buyer by taking back an installment note at the closing of the 1031 property.

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The real estate seller is still protected because the seller carry back note is secured by the 1031 exchange relinquished property. The seller would merely foreclose against and take the 1031 investment property back if the buyer fails to make good on the note.

Of course, the real estate seller should always try to structure an all cash transaction with no seller carry back financing. Seller financing will always complicate the sale of investment property, especially when the seller is also structuring a IRS 1031 tax deferred exchange.

Complications with Seller Financing in a 1031 Investment Exchange

The challenge with seller carry back financing in a real estate 1031 exchange is that the real estate investor ends up with some cash as well as the installment note. The installment note is not liquid and can not be readily converted into cash.

The real estate investor must make a decision as to what to do with the seller carry back note. While seller carry back financing does work within a 1031 exchange, it also significantly complicates the 1031 transaction and can limit the investor’s flexibility in completing the 1031 deferred exchange.

Seller Financing Options within a 1031 Tax Deferred Exchange

There are a number of strategies available to the 1031 investor when a seller carry back note must be used in a IRS 1031 deferred exchange transaction.

1. Sell the 1031 investments with seller financing and decide not to complete a 1031 exchange. Some of the income taxes will be deferred over the term of the installment note. Depreciation recapture taxes are due in the year the 1031 investment property was sold.
2. Sell the investment property with seller financing and complete a 1031 tax exchange but keep the note outside of the 1031. The note can be “carved out” and structured outside of the 1031 tax free exchange transaction and the balance of the cash would be structured inside of the 1031 tax deferred exchange. Depreciation recapture and some of the capital gain taxes will be recognized in the year the 1031 relinquished property was sold. The rest of the capital gain taxes will be deferred over the term of the installment note.
3. Sell the 1031 investment property, carry back an installment note and complete a 1031 exchange with the note inside the 1031 exchange. The note and cash would be included inside the 1031 deferred exchange. The note must be used to pay for the 1031 replacement property, which generally means it must be converted into cash. Income taxes are 100% deferred through the 1031 tax exchange.

There are three options that may work within this strategy:

1. Assign the note to the seller of your 1031 replacement property as part of the consideration for the property.
2. Sell the installment note for cash. This often results in the sale of the note at a discount, which can be very expensive.
3. The real estate seller can contribute additional out-of-pocket cash equal to the face value of the note in order to complete the 1031 tax exchange. The installment note will be assigned to the real estate investor after the 1031 tax free exchange has been completed.

Including or excluding the seller financing in your 1031 tax exchange is not an easy decision. In most cases the inclusion of the installment note with a deferred 1031 exchange will work if there is adequate pre-exchange planning to make sure there is adequate cash to replace the note with.

And, the inclusion of the installment note usually makes sense from an income tax perspective because your depreciation recapture and 1031 capital gain taxes are 100% deferred.

Consult with Legal and Tax Counsel

Seller carry back notes create significantly income tax complexities. Real estate investors should always consult with legal and tax counsel prior to attempting any of these 1031 strategies when purchasing a 1031 investment.

About the Authors:

Exeter 1031 Exchange Services, LLC is a leading national provider of comprehensive 1031 exchange services, which include forward, reverse, and improvement 1031 exchange strategies

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for real estate and personal property. Call Exeter when you are looking for more than just a 1031 exchange processor. They’re available 24/7.

Westwood Net Lease Advisors is a leading investment brokerage firm specializing in triple-net lease properties & alternative passive real estate investments. Learn more about our ‘unique’ buyer services.

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By executing a 1031 deferred exchange rather than a traditional sale you are able to build equity and wealth and save money on taxes. When a 1031 tax exchange is completed, the exchangers sell their investment properties, use the equity to purchase a 1031 replacement property of equal or greater value and leverage the equity into the new property. In a 1031 deferred exchange, the investor will not have to pay taxes on any of the proceeds of the sale if it is all reinvested into a new property. This allows an exchanger to sell an older property that is not maximizing their investment dollars (for example, a structurally obsolete house for which it is hard to find good, dependable renters) and replace it with a property with more potential to appreciate and greater ease of management (for example, a NNN fast food restaurant).

The exchanger must plan ahead to enter into a 1031 deferred exchange. The first step is the exchanger finds a Qualified Intermediary (QI) and they enter into an exchange agreement. The agreement will stipulate that the QI acquires the property to be sold from the exchanger and transfers it to the buyer by direct deed from the exchanger. The QI holds all the funds (cash or otherwise) from the sale in a safe account. Than the QI uses these funds to acquire the 1031 replacement property from the sellers and transfers it to the exchanger by direct deed. Thus the 1031 deferred exchange is complete.

Two requirements must be fulfilled for the 1031 tax exchange to be successful.

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• The exchanger must purchase a 1031 “like kind” replacement properties
• Cash or any other benefit cannot be received by the exchanger or they will have to pay 1031 capital gains tax on any benefit they receive.

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More Deferred 1031 Exchange Facts :

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• There are strict deadlines in exchanges such as 45 days after the sale of the relinquished property the exchanger must identify the property/properties they plan to use to replace the one just sold. They must deliver to the QI (or other party as permitted by the IRS when dealing with a 1031 tax free exchange) in writing the list of potential replacement properties and must purchase replacement properties from this list.
• The purchase of the replacement properties must be completed within 180 days of the closing of the relinquished properties.
• The sold property must have been used for business or investment purposes and exchanger must have the same intentions for the new properties.
• To avoid paying 1031 capital gains, the exchanger should…
  • purchase a property or properties that are equal to or greater than the value of the property sold
  • use all the equity acquired from the sale of the relinquished property towards the purchase of the 1031 replacement properties.
  • obtain the same or greater debt on the replacement property that was on the relinquished property.

For more information about your 1031 deferred exchange speak to your accountant or lawyer. For help in finding the best replacement 1031 property for your 1031 deferred exchange, speak to one of Westwood Net Lease Advisors.

Two buildings were delivered in the East End submarket during the first quarter of 2008.

In 2007, foreign investors bought nearly ten times as much commercial office space in the District as they did in 2006.

NATIONAL FLEX/R&D MARKET

Continued growth in the high-tech sector is keeping demand space very strong in established high-tech hubs.

Sales are down considerably in both number and dollar volume.

NATIONAL WAREHOUSE MARKET

Restraint on the part of developers should allow market conditions to remain relatively healthy.

Increases in vacant space and tighter lending restrictions have reduced the number of trades throughout the country.

NATIONAL APARTMENT MARKET

Financing is still accessible to apartment investors.

Most investors view supply-side issues as the greatest short-term risk to this sector.

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NATIONAL NET LEASE MARKET

The number of offerings increased on a quarterly basis in the first quarter of 2008.

Sellers sense a strong “flight to quality” among buyers.

NATIONAL DEVELOPMENT LAND MARKET

Development opportunities will be difficult to find in the coming months.

Tighter debt markets and more stringent underwriting standards are not easy hurdles to overcome at the present time.

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The supply-demand balances throughout the industry should benefit from development difficulties.

Some of the best development opportunities will likely be in the industrial sector.

Data from: Price Waterhouse Coopers

If you are in a circumstance trying to defer 1031 capital gains by means of a 1031 tax exchange whether actively searching for candidate properties or simply in the beginning stages of deciding you want to go ahead with a 1031 tax free exchange, Westwood Net Lease Advisors can facilitate.

What is a 1031 Deferred Exchange?

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You need to look no further than the Internal Revenue Code to find a golden opportunity to sell certain real estate assets without paying 1031 capital gain taxes. Under the provisions of Section 1031 of the IRC, you can invest your profits from the sale in similar but usually more valuable property and possibly defer the capital gains indefinitely.

Please note several important reasons for you to consider when considering a deferred 1031 Exchange who s your caddy movie download living dying online

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When tax deferred exchanges are handled properly, you will be able to shelter 100% of your potential 1031 capital gains. In effect, the government is giving you an interest-free loan. You can trade from a high-maintenance property to a low-maintenance property. Here is a sample of a typical client of ours in a 1031 tax exchange that occurs at least once a week:

Client wants to sell an apartment building with four short-term tenants for a quality commercial building leased out to Walgreen’s on a long term lease. Walgreen’s will maintain the building and grounds and pay all real estate taxes and insurance premiums. Your revenue stream will remain strong, but the headaches of managing your property will fade away.

By using IRS 1031 Exchanges you can diversify your investment strategy by exchanging one property into three properties should you so desire. You can relocate your real estate investment to a more promising part of town or to an area of the country that is experiencing massive growth. By acquiring Triple Net Lease sweat download download before the devil knows you re dead online Properties you are not bound by boundaries since they involve no management or maintenance. If you are going to own a real estate investment, you might as well own a prime location in a growing area.

Let’s run through a good example of how a 1031 tax exchange can save you lots of money with real facts and numbers.

One of the most important things to remember about 1031 tax exchanges is that the money you would have thrown away in capital gains taxes is instead working for you. You can make a larger down payment on your new property. Here is one example of how a 1031 tax exchange can pump up the power of your investment dollar.

You paid $250,000 for a building 5 years ago, and you are now selling it for $400,000. You depreciated $5,063 for each year ($200,000 divided by 39.5 years=$5,063). Your 1031 capital gains tax would be 15% of your $150,000 profit, or $22,500, plus 25% on the $25,315 you already deducted on depreciation for the cumulative 5 years which adds another $6,328 you owe in taxes. A total tax bill of $28,828 is now gazing you in the face. If you still owed $200,000 on your mortgage and the sale cost you $15,000, you would be left with $156,172 to invest in another piece of property.

However, if you had the foresight to take advantage of a 1031 deferred exchange rather than simply selling one property and buying another, you would have an extra $28,828 to put into your new purchase. Based on a 25% down payment, you would increase your buying power by about $116,000!

A few basic rules of a 1031 tax exchange

• The property you sell and the property you buy must be used in a trade or business or for investment purposes.
• The proceeds from the sale of your original property must be handled by a qualified intermediary.
• Any profit from the original sale that is not reinvested in other 1031 tax deferred properties will be taxed.
• The level of debt on your new property must be equal to or higher than your level of debt on your old property.
• You have 45 days after you sell your old property to identify the new property you intend to purchase for your 1031 tax deferred exchange.
• You must purchase your new property within 180 days of the sale of your old property or by the due date for your tax return for the year in which the transfer of the old property takes place, whichever arrives first.
• You may identify up to three 1031 tax deferred properties for your exchange. If you choose to identify more than three properties, you must purchase at least 95 of the combined value of all the property you list as replacements for your old property.
• You can exchange any real property for any other “like-kind” property within the United States. Examples of property that qualifies for a deferred 1031 exchange include apartments, commercial property, condominiums, duplexes, raw land and rental homes if they are being used solely as an investment.

Property that does not qualify for tax deferred exchanges include your primary residence, stocks and bonds, notes, partnership interests, developed lots held primarily for sale and property that is to be resold immediately after its initial purchase or completion of improvements.

The 45 day rule on your 1031 tax exchange

The Internal Revenue Service gives you 45 days after the sale of your old property to complete the purchase of the new property or to identify the new property or properties you intend to purchase as part of your 1031 tax free exchange. You must provide your intermediary with this list within 45 days, even if the 45th day is on a Sunday or holiday. Your list must be in writing and must note the property’s address and legal description. It can include more than 3 properties if their combined value is less than twice the value of the property you sold.

The 180 day rule for your 1031 tax exchange

You must complete your 1031 deferred exchange within 180 days of selling your old property by purchasing one or more of the properties on the list you submitted to your intermediary within 45 days of the sale of your old property. You cannot buy property that was not on your list.

There are many other rules and nuances related to 1031 tax changes which can’t be listed in one article. Please be to sure visit our 1031 exchange section where we are starting to collect a large library of informative 1031 related articles.

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