Starker exchange or 1031 and installment or note

Because the note would have to be completely paid during the exchange period, the maximum term of the note is the earlier of days or when the replacement property closing occurs. The second option is for the investor to buy the note from the QI. In order to avoid the possibility of constructive receipt, most tax advisors recommend that this occur at the closing of the replacement property. The QI then uses the funds to purchase the replacement property at that closing.

Finally, the investor can arrange for an unrelated third party to buy the note. The proceeds from the sale would go directly to the QI as exchange proceeds, and the QI uses those proceeds to buy the replacement property. Occasionally, a seller is able to use the note as partial payment for the replacement property.

In this scenario, the QI assigns the note to the seller of the replacement property at the closing. Using this option, the seller acts as a third party lender and deposits cash in the amount of the loan into escrow.

The buyer uses the loan funds to acquire the property, and then escrow delivers those funds to the QI for use in the exchange. First American Exchange Company, LLC a Qualified Intermediary, is not a financial or real estate broker, agent or salesperson, and is precluded from giving financial, real estate, tax or legal advice. It gets more complicated from here on out because your Qualified Intermediary is holding more than just cash in your Exchange account.

How does your Qualified Intermediary use the seller carry-back installment note to acquire your like-kind replacement property? Including or excluding the seller carry-back installment note within your Exchange is not an easy business decision. In most cases the inclusion of a seller carry-back note with a Exchange will work if there is sufficient pre-exchange planning to ensure the availability of the proper liquidity to fund the transaction.

And, the inclusion of the installment note usually makes sense from an income tax perspective. However, you should decide whether you would even want to accept a seller carry-back installment note as part of your Exchange transaction, or avoid the headaches involved with a seller carry-back installment note and insist on an all cash transaction for the purchase of your relinquished property.

You should always consult with your legal and tax advisors as well as your Qualified Intermediary prior to completing a seller carry-back installment sale as part of your Exchange transaction.

The inclusion of the seller carry-back installment note inside your Exchange transaction will defer the recognition of your depreciation recapture and capital gain income tax liabilities. Excluding the seller carry-back installment note from your Exchange transaction will result in the immediate recognition of your depreciation recapture income tax liabilities in the year in which the sale of the relinquished property closed, and your capital gain income tax liabilities will be deferred and recognized over the term of the seller carry-back installment note.

Section of the Internal Revenue Code and Section 1. Your capital gain income tax liabilities are deferred over the term of the installment note and recognized paid on a pro-rata basis as principal payments are made against the installment note. Although this portion of the capital gain income tax liability will be recognized immediately, the IRS will allow you to defer the actual payment of the income tax liabilities over the term of the note and will assess interest on the deferred income tax liability.

Interest income earned on your seller carry-back installment note is taxable as ordinary income, and is taxable to you in the year in which the interest income is paid to the holder of the note whether the installment note is included or excluded as part of your Exchange. The holder of the note is generally responsible for filing IRS Form that will report the amount of interest paid by the borrower to the IRS.

The servicing agent or collection agent is generally responsible for filing IRS Form INT that will report the amount of interest income received by you as the lender under the seller carry-back installment note.

Why The Exeter Group of Companies? Seller Carry Back Notes and Exchanges You may be requested by real estate buyers from time-to-time to assist them in the acquisition of your real property "relinquished property" by helping them with the financing. Seller Carry Back Note — Inside or Outside the Exchange Special planning is required when you intend to complete a Exchange and carry-back an installment note as part of the Exchange transaction.

Excluding the Note from the Exchange — Installment Sale Treatment Should you decide to exclude the seller carry-back note from your Exchange transaction, the promissory note and the corresponding deed of trust or mortgage would be drafted with you listed as the beneficiary or owner of the promissory note. Excluding the Note from the Exchange — Structured Sale Strategy You could also decide to exclude the seller financing from your Exchange, but to include the seller carry back note inside a Structured Sale.

Including the Note as Part of the Exchange — Exchange Treatment On the other hand, should you decide to include the seller carry-back installment note as part of your Exchange transaction, the installment note and corresponding deed of trust or mortgage would be drafted with your Qualified Intermediary listed as the beneficiary or owner under the installment note and corresponding deed of trust or mortgage. Including the Note as Part of a Reverse Exchange Although Reverse Exchanges are even more complicated and involved, seller carry-back notes may also be utilized within a reverse Exchange structure depending on your circumstances.

Complications with Including the Installment Note in the Exchange Structuring and closing the relinquished property sale transaction with the seller carry-back installment note included as part of your Exchange is the easy part. There are really three 3 potential solutions: You can use the installment note as part of the consideration paid for the purchase of your like-kind replacement property.

This solution, however, assumes that a seller would be willing to accept the third-party installment note as full or partial consideration their property. Barnes Walker. Selling Your Home. Real Estate Investing. Income Tax. Actively scan device characteristics for identification. Use precise geolocation data. Select personalised content. Create a personalised content profile.

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What Is Section ? Special Rules for Depreciable Property. Changes to Rules. Moving Into a Swap Residence. Changing Ownership After a Exchange Depreciation Recapture. The Bottom Line. Key Takeaways A exchange is a swap of properties that are held for business or investment purposes. The properties being exchanged must be considered like-kind in the eyes of the Internal Revenue Service IRS for capital gains taxes to be deferred. If used correctly, there is no limit on how frequently you can do exchanges.

The rules can apply to a former primary residence under very specific conditions. What is an Example of a Exchange? What is Exchange Depreciation Recapture? Article Sources. Investopedia requires writers to use primary sources to support their work.

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