The Best Way to Handle Earnest Money Deposits when Conducting a 1031 Exchange

So you're doing a 1031 exchange, you’ve sold your relinquished property, and parked your proceeds with the intermediary. If you're like a lot of real estate investors you are real estate rich and cash poor. You don't have a lot of extra cash laying around to advance for an earnest money deposit.

Making an Earnest Money Deposit

How can we make an earnest money deposit on the replacement property if all of your cash is tied up in the 1031 intermediary’s account?

Very easy. Enter into a purchase agreement for the replacement property, give it to the intermediary and say: “Hey intermediary, please assign yourself into this contract so that you can advance a portion of the exchange funds to the seller or the seller's title company as the earnest money deposit.”

Once you have a contract for the replacement property it's very easy to assign that contract to the intermediary so that they step into the shoes as the buyer of that property and can advance the exchange funds.

Be Careful with Loan Related Expenses

What you can't advance money for are loan related expenses, so if you have a loan origination expense don't plan on funding that out of the exchange account.

Sometimes taxpayers don’t want to wait for the slow intermediary to wire transfer the earnest money deposit. Instead they want to write a check and attach it to their offer so it looks more appealing to the seller. Then they say “when can I get my earnest money cash back?”

At the closing of the replacement property you can instruct the settlement agent to not apply the earnest money deposit towards the purchase price, but instead to refund your money at the time of closing. Then your intermediary can come in with all the 1031 funds to fund the acquisition and you’ll get that earnest money back at closing.

• 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

What to Know About Earnest Money Deposits in a 1031 Exchange

Many people have questions about the earnest money deposit on the sale of their old relinquished property in a 1031 exchange. Oftentimes a title company or real estate broker will hold the deposit from the buyer as a fiduciary both for the buyer and the seller. They're acting as a sort of neutral third party to hold this deposit.

In the normal sequence of events the closing will eventually occur and that earnest money deposit will be applied towards the purchase of the relinquished property. Then all of the net proceeds, all of the consideration for the sale, will come to the qualified intermediary. That's just fine so long as that earnest money deposit is merely just a deposit.

It's not the sellers deposit until the closing is fully complete. So the deposit is really sort of in limbo until the closing occurs and the benefits and burdens of ownership shift.

Nonrefundable Earnest Money

There is a subset of deposits that you do need to be more careful with. That is the hard, nonrefundable earnest money deposit that effectively is the sellers cash once the deposit is made.

In those situations, you want to insulate the taxpayer that's doing the exchange from taking and holding their own deposit and instead have that deposit placed with the qualified intermediary who's ultimately going to receive all of the cash proceeds from the sale of the old property.

So with hard nonrefundable money you need to coordinate with your qualified intermediary before the deposit is paid over to make sure that you don't inadvertently receive the proceeds for the deposit.

• 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.

© 2019 Copyright Jeffrey R. Peterson All Rights Reserved

Earnest Money Deposits in a 1031 Exchange

In this 1031 FAQ video, Jeff Peterson talks about earnest money deposits in a 1031 exchange. Watch more 1031 educational videos here.

• Start Your 1031 Exchange: If you have questions about earnest money deposits in a 1031 exchange, feel free to call me at 612-643-1031.

Defer the tax. Maximize your gain.

© 2017 Copyright Jeffrey R. Peterson All Rights Reserved