How to Use a Contract for Deed to Acquire 1031 Exchange Replacement Property

Let’s say you’re at day 170 of your 180 day 1031 exchange period and you don’t have your new replacement property lined up and ready to go. What happens? Are you forced to pay the capital gains taxes and not do a 1031 exchange?

Cutting it Close in a 1031 Exchange

We’ve had clients who have gone right down to the wire on their 180 day exchange time frame. In one instance, it was caused by a snafu with the bank. For whatever reason, the bank could not get the financing approved. The seller was willing, the buyer was willing, but the bank had some sort of difficulty. Without the bank’s money, it’s hard to close on the replacement property. So we said to the client: “why don’t you approach the seller and offer to buy the property on a short term contract for deed, under which the buyer receives equitable title.”

Purchasing a property via a contract for deed is a clever way to get a deal done so that the client can identify their identified replacement property within the 180 day time frame.

In the Midwest, land contracts and contracts for deed are very popular. This particular client that we were working with was in New York, where they don’t do a lot of contracts for deed. So depending on your geographical location, the local customs and practices may dictate the extent of your options.

Contact a Qualified Intermediary

If you’re considering a 1031 exchange, contact a qualified intermediary at CPEC1031 today to work through the details of your transaction. Contact our qualified intermediaries today at our office in Minneapolis to get your 1031 exchange off the ground!

• 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

3 Rules for Selling on a Contract for Deed While Doing a 1031 Exchange

While a selling on contract for deed is usually a good method of seller-back financing because of the harsh and expedient enforcement mechanisms; if the Seller wants to defer 100% of the gains through a 1031 exchange, then it may be more advantageous to convey the Relinquished Property by deed and to take back a Note and Mortgage made in favor of CPEC1031, LLC (the Qualified Intermediary or "QI").

That way, prior to the purchase of the Replacement Property, the Exchangor can send the QI the outstanding amount due on the Note to buy the Note form the QI.  Once the QI has all cash in the 1031 escrow account, all of the Exchangor's equity (cash proceeds) from the disposition of the Relinquished Property may be applied to the purchase of the Replacement Property.

It is much more cumbersome to get the same result using a contract for deed because it requires the Exchangor to actually deed the Relinquished Property to QI, then the QI has to convey the Relinquished Property to Purchaser by Contract for Deed and later (just prior to the closing of the Replacement Property) the Exchangor has to purchase the contract back from the QI.

3 General Rules

There are three general rules of thumb to quickly see if you will defer all of the recognition of gain.

1. Typically you will acquire replacement property that is “up or equal” in Value (price);

2. You will roll over all of your Equity (net proceeds) from the relinquished property into your replacement property;

3. And to the extent that you were relieved of liabilities and debt, such as mortgages on your old relinquished property, the debt relief is offset by (1) new liabilities or mortgages taken on in conjunction with your purchase of the replacement property; OR (2) by investing additional cash in the replacement property equal to the amount of liabilities and debts that were discharged.

Generally, people prefer not to put the QI into the chain of title and want to avoid the extra costs and recording fees that may entail.  A Note and Mortgage are just an easier form of seller-back financing when you are loaning your buyer money on the sale of your Relinquished Property and also trying to juggle the requirements for 1031 exchange perspective.

• 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

Can I Do a 1031 Exchange on My Contract for Deed Balloon Payoff?

Contract Deeds or Executor Contracts, basically installment sales, create a lot of questions. Here is one that I get a lot. I sold my property ten years ago on an installment sale, a Contract for Deed. And now, I am being paid off, and I am getting this balloon payment from the buyer. Question: Can I do a 1031 Exchange on this influx of cash that I am receiving?

Understand the Timing – When Did the Sale Take Place

If you look at this transaction, it may appear that the sale is now occurring because when the balloon payment is given to the vendor, the deed will be delivered to the vendee. So, it feels like perhaps the sale is occurring now. But, for Federal Tax purposes, the sale probably occurred ten years ago when the Contract for Deed or the installment sale was entered into.

Who is Really the Owner of the Property

When a Contract for Deed is given, the purchaser or vendee is considered to be the equitable owner of the property. They probably bear the risk of loss if the property is destroyed. They probably bear the burden of paying the property taxes to the local property tax assessor. And, under the contract, they probably enjoy the possession, the exclusive use of the property. So, for Federal Tax Purposes, the Contract for Deed vendee probably acquired the property way back when the initial Contract for Deed was entered into. Now, when this influx is coming in, we are not really selling the property anymore, we are just receiving payoff like any other lender who has loaned money to a purchaser.

Section 1031 Does Not Apply to "Evidence of Indebtedness"

When a Contract for Deed vendor holds that legal title, they don't necessarily own the property anymore. They really own an enforcement mechanism. In the event of a default under the Contract for Deed, they can swoop in and cancel the Contract for Deed. This is an enforcement mechanism much like a mortgagee's interest or bank's interest in a mortgaged property. They are really a creditor, not so much a property owner for Federal Tax Purposes.

Your Go-To 1031 Resource

Like-kind exchanges allow taxpayers to defer capital gains taxes when selling investment real estate. CPEC1031 is your go-to source for all things related to 1031 exchanges. Our qualified intermediaries have decades of experience working on 1031 exchanges of all sorts. We can answer all of your questions, advise you on your replacement properties, and prepare your 1031 exchange documents so you are ready for the closing table. Contact us today at our downtown Minneapolis office to discuss your 1031 exchange.

• 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.

© 2018 Copyright Jeffrey R. Peterson All Rights Reserved

Can you 1031 Exchange Property you Already 'Sold' on a Contract for Deed?

A client of ours recently sold a house under a contract for deed with the balloon going due in 2019. The client wanted to know if it would be possible to do a 1031 exchange on the property after receiving finial payment for it in 2019? That's our topic for this article.

Contract for Deed

If you already 'sold' a property on a contract for deed, can you do a 1031 exchange once you get paid-off on the seller-backed financing? Possibly not because the IRS may no longer view you as the equitable owner for tax purposes. Here are some questions to consider:

• Are you the holder of a lender's interest now?

• Who has the risk of loss if the property is damaged or destroyed?

• Who has the obligation to pay taxes and insurance?

• Who has the ability to depreciate or deduct expenses related to the property?

• Is the contract for deed vendee in exclusive possession of the property?

• If the contract for deed vendee constructed improvements on the property, who would own the improvements?

The answers to these questions will help you determine your viability of a 1031 exchange. As always, it's important to consult with a qualified intermediary about your 1031 situation.

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

Defer the tax. Maximize your gain.

© 2017 Copyright Jeffrey R. Peterson All Rights Reserved

LLC Membership Interest & Transfer Tax in a 1031 Exchange

What if you own a property in a single member LLC and you’re approached by a potential purchaser who does not want to buy the land, but wants to buy your single-purpose LLC that owns the land.

Questions to Ask

The first question to ask is why does the buyer want to purchase your LLC as opposed to purchasing the land itself?

The answer may hinge on the fact that when you assign the membership interest in the LLC there's no deed recorded. Therefore, the local tax assessor may not be aware that there's even been a sale of the property.

Transfer Tax

Some questions arise as to whether or not that may violate the local states rule with regard to transfer tax.

Many states have broadened the language that applies to an instrument that transfers title to encompass both deeds, as well as other instruments that transfer the property.

So a seller may still have a statutory obligation to pay transfer tax even if they don't transfer the property by deed. By circumventing the normal closing process they may still have the obligation to pay that transfer tax.

If you're going to do this kind of transaction you may want to extract from that buyer an indemnity to protect yourself from any liability for your failure to pay the transfer tax.

Further, there are all kinds of questions about whether or not a conveyance by an assignment of the membership interest still allows you to convey the property and do a standard 1031 exchange.

Consult Your Tax Advisor

You may need to consult with your tax advisor and your attorney to make sure that your sale of the membership interest does not make it difficult for you to do a 1031 exchange.

• Start Your Exchange: If you have questions about LLC membership interest, transfer tax, or other 1031 exchange issues, feel free to call me at 612-643-1031.

Defer the tax. Maximize your gain.

© 2017 Copyright Jeffrey R. Peterson All Rights Reserved