Escrowing Funds for Post-Closing Repairs in a 1031 Exchange

In a 1031 exchange, can you escrow funds for post-closing repairs and improvements, or could that be considered boot? That is a good question. First and foremost, you may want to talk with your CPA or tax advisor about this.

1031 Exchange Basics

1031 exchanges are for like kind exchanges of real property for real property, and if you get any other property or cash as part of the exchange (non-like-kind property is called “boot”), then that property or cash may be taxable.

Ideally the repair would be paid for and completed by the seller before you close on the purchase of the replacement property, that way there is no need to hold an escrow for your benefit (to pay for post-closing repairs and improvements).

The risk of escrowing cash for your benefit to pay for post-closing repairs and improvements is that it may be considered taxable boot. The escrow may not be considered like-kind property.

Holdback Credits

Holdback credits do not work. An approach instinctively utilized by many realtors and escrow companies to handle minor repairs to Replacement Property is to have repairs performed at the Seller's or Accommodator's expense after the Replacement Property is conveyed to the Exchanger. This approach does not work because the Exchanger is not receiving like-kind property when the Exchanger receives post-closing repairs.

Treas Reg § 1.1031(k)-1(e)(4) specifically provides that "additional production occurring with respect to the replacement property after the property is received by the taxpayer will not be treated as the receipt of property of a like kind.

Please check with your tax advisor on this issue.

• 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 Methods for Securing Your Money in a 1031 Exchange

A 1031 exchange requires you to move all of the sales proceeds from your relinquished property over to your replacement property. You want to avoid receiving any of these funds during the process, because doing so will trigger taxable boot. So how to you ensure that your 1031 exchange funds are secure during your transaction? In this article, we are going to offer three tips for securing your funds in a 1031 exchange.

Separate Escrow Account

Working with a qualified intermediary is the best way to make sure your funds are safe and secure throughout the like-kind exchange process. Find a company that deals exclusively with 1031 exchanges. Your intermediary can set up a separate escrow account and have the net proceeds transferred into that account after the relinquished property closing. This is where the funds will remain until you are ready to acquire your replacement property.

Escrow Agreement

You should also have the bank enter into an escrow agreement with the intermediary that will lock down the funds unless you have co-authorization from you and the intermediary to withdraw.

Work with a Reputable Qualified Intermediary

Finally, you should make sure that your qualified intermediary has a Fidelity Bond and an errors and omissions policy so you have all of your bases covered.

Minnesota Exchanges of Real Property

CPEC1031, LLC works with clients in many different industries and states on their 1031 exchanges. Working with an intermediary on your exchange is one of the best ways to ensure a successful exchange. Our intermediaries have twenty years of experience facilitating exchanges in Minnesota and around the country. Contact us today to speak with one of our 1031 exchange professionals about your real estate 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.

© 2020 Copyright Jeffrey R. Peterson All Rights Reserved

Funding Escrow in a 1031 Exchange - Cash vs. Sales Proceeds

In a 1031 exchange, can the seller use sales proceeds to fund the “escrow” account and still defer all taxes related to the sale, or does the seller need to bring cash to closing to fund the escrow? In this blog, we'll discuss this question through the lens of a client's recent 1031 situation.

Background

First, a little bit of background. In this case, the client had to get cash to the buyer at closing as part of a roof/HVAC concession. For the buyer’s financing reasons, he didn’t want it to come right off the purchase price. The client was hoping to get the cash to the seller as a “commission” expense to him since he was unrepresented. However, the buyer was financing through the SBA, and the SBA required an escrow account. Considering all of this, the client wanted to know if they needed to bring cash to the closing in order to defer the tax, or if they could use the sales proceeds to fund the escrow.

Transactional Expenses in a 1031 Exchange

Funds from the sale of the relinquished property may be used to pay customary transactional expenses including attorneys fees related to the disposition of the relinquished property and the 1031 exchange. However, if you have already paid the attorney the fees you typically may not be reimbursed with exchange funds during the exchange period.

The "G(6) limitations" impose stringent limitations on your ability to receive actually or constructively any proceeds from the relinquished property during the exchange period.

Unused Escrow Funds

If there are unused / unspent exchange funds remaining in the 1031 escrow account after the purchase of the last replacement property (at the end of the exchange period), these un-utilized proceeds may go back to you to reimburse you for expenditures you made for the exchange such as attorneys fees that you already paid.

You may want to discuss this with your CPA or tax advisor because reasonable people can differ in their approach to this topic.

• Start Your Exchange: If you have questions about escrow 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

1031 Exchanges & Escrow

It's really sad when we get a call from somebody and they say “I sold my relinquished property two weeks ago and I've just decided to do a 1031 exchange. Can you set me up to do a 1031?”

This call comes in quite frequently, partly because people are ignorant about the requirements of Safe Harbor 1031. They think that they can just keep their money in an escrow account or leave the money with the title company and if they choose to do at 1031 they can set it up after the fact.

Be Prepared

The problem is that in order to do a valid Safe Harbor 1031 you have to have an exchange agreement with a qualified intermediary (or facilitator/accommodator) in place before you dispose of the relinquished property. Furthermore, you have to assign your rights in the purchase agreement with the buyer so that the relinquish property purchase agreement is assigned to the intermediary. The intermediary then directs you to deed that property straight to the buyer.

Notice of Assignment

On top of that you have to give written notice of your assignment to the intermediary to all of the other parties to the purchase agreement (e.g., the buyer of the Relinquished Property). If you don't have all of that in place before the closing occurs on the sale of your relinquished property then you don't have a defensible Safe Harbor 1031. The net result is that closing, when the benefits and burdens of ownership shift to the buyer who has actual or constructive receipt of the money.

Even if you leave your money in an escrow account at the title company, it's still your money. You still have the right to go in and take it out at any time (you have control over the proceeds). The only way to do it under the Safe Harbor regulations is to make sure that you have it set up with a facilitator or intermediary before you go to closing and dispose of that property so that you’re insulated so you don't have actual or constructive receipt of the funds.

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

Defer the tax. Maximize your gain.

© 2016 Copyright Jeffrey R. Peterson All Rights Reserved