Motives may include: * The seller is looking for a long-term income stream for retirement * The seller would like to spread the tax exposure of the sale over time * The property is not currently financeable * It is necessary to close the sale before financing is available * The buyer intends to flip the property and only needs short-term financing
It is essential that both the buyer and seller understand the terms of the contract. Both should have their respective legal council's approval before authorizing any note. Along with the opportunities of these arrangements come obstacles. Traditionally a tax-deferred exchange was thought to be one of them.
Using a Tax-Deferred Exchange In today's economic environment the use of seller financing may be necessary in order to simply sell a property. A common misunderstanding of installment sales is their impact on a tax-deferred exchange. Despite what many investors may think, it IS possible to satisfy an exchange and provide seller financing.
Since a note typically represents equity in a property and a 1031 Exchange requires all equity to be carried forward in order to be completely tax deferred, it is necessary to somehow use the note in the exchange. In order for a note to be used in an exchange, the Exchangor must not have had actual or constructive receipt of the note. The note must be held by the Facilitator at the close of escrow just as any cash must be.
The following are options available under these conditions:
1. As the Exchangor, you can direct a third-party 1031 exchange intermediary to sell the note to a third party such as a bank, pension fund manager or a private investor. The proceeds from the sale of the note are then deposited with the intermediary. You will need to deposit additional cash to offset the amount that was discounted on the note for total tax deferral. If the additional cash is not deposited, you will have tax exposure on the difference between the note's value and the discounted sale price of the note if any.
2. The Exchangor can use the note along with the cash to acquire the replacement property. The Seller of the replacement property now owns the note.
3. The Exchangor can also purchase the note from a third-party. The note has now been converted to cash and the exchange can be completed. The Exchangor now benefits from the interest generated by the note, yet does not have a capital gains tax exposure to the gain the note once represented.
4. If the note is short term and matures inside the 180-day exchange period, it is possible to complete the exchange after the note is paid off.
Understanding the motivation behind the sale and the use of the note often dictates the appropriate tax deferral option to be utilized. A careful review of the choices available and their respective tax consequences is critical. A tax specialist or legal counsel will be able to help you make the right decision given the time and information available. Seller financing in today's world can be just the tool to help you make that next deal.
~David Moore, 2009
A 1031 exchange is a method often used by investors in real estate in order to indefinitely defer capital gains tax liability on a property's sale. This is achieved by relinquishing rights to a property one would like to sell to a qualified intermediary, who holds the funds gained from the sale of the relinquished property and uses the money to buy a replacement property that fulfills the regulations delineated in Section 1031 .
Although the current (and growing) popularity of the 1031 might lead you to believe that it only recently came on the scene, this is not actually true. As a matter of fact, the history of the 1031 stretches all the way back to 1921, though at its conception, it was quite a bit different than what we currently think of as an exchange. Section 1031 really came into its own in the seventies, which saw many important modifications in the way that exchanges were conducted. These modifications paved the way to a farther-reaching conception of the exchange process and created greater interest from investors.
The capital gains tax deferral Section 1031 provides to the investor might, at first glance, appear to be a gift from the US government, but it is, in reality, closer to an interest-free loan. This is because there is an expectation that the taxpayer will repay the extra funds gained from the deferral by accepting capital gains liability upon the eventual sale of a replacement property. Additionally, this interest free loan may be kept for an indefinite period of time; an investor can conduct any number of exchanges before finally electing to sell outright, at which point taxpayer must pay capital gains taxes.
Section 1031 of US tax code represents a mutually beneficial agreement between the investor and the United States government, profitable for the U.S. economy as a whole in addition to the individual investor. By looking upon the transfer of money in an exchange as representing an extension of an existing investment rather than as a discrete transaction liable to be taxed, investors gain the opportunity to move their funds to the most profitable possible investments, which, in turn, boosts the country's economy by bolstering the growth of new jobs.
Like anything else, the 1031 exchange has its skeptics. Some advocates of change in Section 1031 will pose the argument that the tax-free income gained by to the investor in the exchange process lends them an unfair advantage. Another common issue of concern is that the strictness of the time limits attached to steps in the exchange process could engender a frenetic rate of buying, with a resultant increase in asking prices for replacement properties. The aforementioned complaints, however, are only tenuously linked to reality, and the odds that the 1031 exchange procedure will go through any significant change in the coming years are quite low. In general, most will agree that Section 1031 is immensely beneficial to all parties involved, allowing investors increased profits on the sale of their property while also encouraging the creation of jobs and consequently promoting the greater good of the U.S.. Little doubt exists that the 1031 is destined to be a mainstay of the investment world for years to come.
Both David Moore & Theo Carter are contributors for EditorialToday. The above articles have been edited for relevancy and timeliness. All write-ups, reviews, tips and guides published by EditorialToday.com and its partners or affiliates are for informational purposes only. They should not be used for any legal or any other type of advice. We do not endorse any author, contributor, writer or article posted by our team.
David Moore has sinced written about articles on various topics from Abdominal, Cars and Fat Loss. David Moore is the CEO of Equity Advantage, Inc., a nationally recognized 1031 Exchange facilitation leader.Learn how a