Presenting Offers with 1031 Exchange Language

Both when buying or selling a property, the counter-party must be informed of the intention of your client to perform a 1031 exchange.  The wording in the contract is usually placed in the Special Provisions section of the contract, with the following wording, or very similar to it:  Seller is aware that Buyer intends to perform a 1031 Tax Deferred Exchange pursuant to Section 1031 of the Internal Revenue Code.  Seller accordingly agrees to an assignment of the rights under this contract by the Buyer to (Name of Qualified Intermediary), a Qualified Intermediary.  Seller agrees to cooperate in such exchange at no cost or liability to Seller.

Sometimes the other party, or their agent, is completely unfamiliar with what a 1031 exchange is.  Here, it is important for your Realtor working on your behalf to be able to explain what it is in easy to understand terms, rather than relying on them to google it, and get lost in something that seems complicated, and subsequently shy away from your offer, assuming you are the Buyer in this case.

I usually explain it by stating that the transaction will operate in exactly the same way as an ordinary transaction would, and will not affect the counter party in any substantial way.  The only difference that they will see is where the money comes from - the QI instead of the buyer themselves.  I simply explain that this QI is acting on behalf of the buyer, and must follow the buyer's instructions in dispersing the funds, which belong completely to the buyer.  All other facts of the contract remain the same.

For a seller doing a 1031, it is just a matter of putting the wording in the contract.  Nothing is really seen differently from a buyer's side in that case, except for some wording on the HUD-1 settlement statement.  I usually just explain that this wording must be put into the contract to show legal intent of the seller to do an exchange, and nothing more than that.  It will not affect the transaction.

What "Like Kind" Really Means and Why You Don't Have to Find Someone to Swap Properties With

Ok, these two topics come up frequently enough with people unfamiliar with 1031 exchanges that I thought I should address them both.  First, let's talk about Like Kind, and what that means according to the law.  For my clients, it is as simple as "real estate" for "real estate".  This means that you can exchange an apartment building for raw land; a commercial office building for a residential rental home; a fourplex for a motel.  The only caveat is that it be used for income generating purposes or investment, NOT as a personal residence.  But that's it.

There is the misconception that this like kind provision means that it has to be the same type of real estate.  Not True!  The things that you cannot do in a valid 1031 exchange are trade say, an office building for gold, or an airplane for a rental condo.  Here, you are breaking the like-kind provision.  But as long as you stick to real estate for other real estate, you are fine.

Another common misconception I find is that you actually have to find someone that wants your property, and you want theirs, in order to do an exchange.  That would be tough!  In fact, I have yet to see it happen.  One party may want to trade with another, but to have this kind of agreement between both sides is exceptionally rare.  Even when it does happen, still, one or both parties still likes to "look around" to see what else they can get, just like any other buyer would do.  This exchange in a pure sense does not make sense for most people, since finding a counterparty that is in agreement and wanting the same thing is like finding a needle in a haystack.

The 1031 exchange provisions allow a seller to liquidate their real estate asset, have the money held by an intermediary, and then be able to purchase ANY property that they choose.  No need for the counter-party to even be involved in swapping or trading, other than notifying them that you are doing an exchange.  For the counter party, it is a transaction just like any other, from both the buy and sell side.  Call me for more details, or visit my site, www.1031exchange.co

Money Placed with a Qualified Intermediary Cannot Be Touched

In doing a 1031 exchange, it is vital that a client never touch any of the proceeds from the sale of the relinquished property.  These funds must be placed with an intermediary at the closing of the sale, if being used to purchase the replacement property.  Sometimes people like to keep some of the cash proceeds from the sale, and this is permissible, so long as instructions are given to the QI beforehand.  Documents can then be prepared showing that the amount of cash that is kept is outside of the exchange.  Keep in mind, however, that this cash will be taxed.  If there is any money left over with the QI after the exchange has taken place, an investor must still wait for the 180 days to be over before getting the remainder of the cash back.

Another thing to remember is that when you are purchasing your new property, only the earnest money can come from the funds held by the intermediary.  I suggest to clients that the option money (in Texas contracts), as well as the cost of an inspection, and loan fees payable up front be paid directly by the buyer.  This is because, if you, as the purchaser, do not close on the property, there is a chance that you will be deemed to have "touched the funds", thereby invalidating the whole exchange.

These rules may seem strict, but need to be followed closely so that your 1031 exchange is airtight against the taxing authorities if they ever argue the case.  For more information, check out our site at www.1031exchange.co