A Few Important Things to Know About Bank Financing in a 1031 Exchange

Many taxpayers conducting a 1031 exchange have questions about bank financing in a 1031 exchange transaction. Here are a few tips and things to know when it comes to bank loans and 1031 exchanges.

Bank Loan Agreement

The banks’s loan agreement may require the exchangor (through the intermediary) to exhaust the 1031 funds for the purchase of the replacement property and for the first construction draws before the banks loan funds will be disbursed. The bank cannot take a security interest in the 1031 funds held by the intermediary.

The taxpayer conducting the exchange may co-sign or provide a personal guarantee of the bank’s loan.

The ‘due on sale clause’ in the loan may need to be modified to allow for the transfer of the replacement property to the exchangor during the 180 day exchange period.

Depending on the number of exchangors, the 1031 exchange may be completed by:

1. deeding the replacement property from the LLC to the exchangors (with a corresponding mortgage assignment/assumption); or

2. by the intermediary assigning 100% of the membership interest in the LLC to the exchangor (which may negate the need for a formal mortgage assignment/assumption).

Items to Request

In a 1031 exchange with bank financing, you should request the following items:

• Prior Exchange Documents. Copy of the signed relinquished property 1031 documents from the sale with confirmation of the amount of funds held by the intermediary (we need to confirm who and how the old relinquished property was vested in title). The 1031 identification of replacement property should include a description of the new land plus the to-be-built improvements.

• Fresh LLC to hold title to the Replacement Property. Copy of the LLC articles, certificate of organization, operating agreement and authorizing resolution appointing the officers (this LLC will likely be 100% owned by the intermediary);

• Title Commitment for the new Replacement Property.

The loan documents may need to be modified to limit the liability of the intermediary.

• Start Your 1031 Exchange: If you have questions about 1031 exchanges, feel free to call me at 612-643-1031.

Defer the tax. Maximize your gain.

© 2021 Copyright Jeffrey R. Peterson All Rights Reserved

1031 Case Study: Bank Rules & 1031 Exchange Protocol

Recently, a client came to us with the following 1031 exchange scenario. The client was looking to do a like-kind exchange on their condo. After crossing their t’s and dotting their i’s with 1031 exchange protocol, they discovered that the rules for 1031 did not coincide with the banking protocol.

The Importance of Qualified Purpose

In order to qualify for 1031 treatment, the client would have to rent the condo out for two years in order to satisfy the qualified purpose requirement. This did not gel with the banking protocol. The bank would not allow a regular loan if the client was to rent out their newly purchased property. This means that in order to qualify for 1031, the client must change it to an investment loan, have a different type of appraisal done, and acquire a higher interest rate for this new type of loan - all which is more than likely add time to the approaching 1031 deadline. 

Preparing for Your 1031 Exchange

The replacement property must be held for a qualified purpose of investment or business use; that may or may not necessitate an investment loan. To some degree the lender may be able to underwrite it as a regular loan. This is why it’s always a good idea to prepare for your 1031 exchange as early as possible to ensure it complies with all parties involved.

• Start Your Exchange: If you have questions about bank rules and 1031 exchanges, feel free to call me at 612-643-1031.

Defer the tax. Maximize your gain.

© 2017 Copyright Jeffrey R. Peterson All Rights Reserved