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

Tips for Earnest Money in a 1031 Exchange

Can the earnest money deposit for the replacement property be paid from the exchange proceeds that are held by the qualified intermediary in a 1031 exchange?

Earnest Money in a 1031 Exchange

Many real estate Investors are real estate rich but cash poor. They don't have a lot of extra money in the bank account to make a substantial earnest money deposit. So if they want to make an offer that looks impressive, one that will catch the eye of the seller with a substantial earnest money deposit, they need to tap into the funds held by the qualified intermediary to advance that large deposit.

Treasury Regulations

Fortunately, the treasury regulations permit the intermediary to advance the 1031 funds to the seller or oftentimes to the seller's title company, provided that the intermediary is assigned into the purchase agreement and that proper notice is given to the other parties. In a competitive market and with the extra pressures of the exchange deadlines looming, exchangors often want to lock-in a replacement property under contract. They really want to make strong purchase offers. We frequently will help the taxpayer advance the 1031 funds needed for the earnest money deposit and help them be the winning bidder in this tight seller's market so that their offer is most advantageous and appealing to the seller.

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

Defer the tax. Maximize your gain.

© 2016 Copyright Jeffrey R. Peterson All Rights Reserved