Increasingly, sellers are becoming more flexible and carrying paper (taking back a note) in order to close escrow on their investment properties. So, how does that work in the context of a 1031 exchange? Can it still be done?
To answer this, I’ll need to introduce you to a very smart guy, Bill Exeter, who owns and operates Exeter 1031 Exchange Services. I was down at his office in San Diego yesterday so we could visit on his internet talk radio show. (To hear the transcript, you’d have to click on “Listen to Prior Recorded Shows” for April 7, 2008).
Between his website and his radio show archives, there is nothing you can’t find related to the 1031 exchange, and he actually taught me a lot about how real estate notes figure into the 1031 equation.
Sellers who have created a seller carry back note on their down-leg property (which is a good technique for getting top dollar and a quick close), have several options when moving into their up-leg property:
(1) Ask the seller to take an assignment of the note as part of the offer. Usually sellers are not too excited about this option.
(2) The up-leg buyer (note holder) could contribute cash into their own 1031 exchange (boot paid) in order to complete the 1031 exchange. Then they would get the note assigned back to them AFTER the 1031 exchange has been completed (boot received). The boot items net to zero so there is no tax issue.
(3) Sell the note for cash, which is then credited to the up-leg seller to complete the exchange. It’s important to remember to have the exchange company listed as the beneficiary on the note. It would also be a good idea to consult with a note professional before you create the note so you know you can sell it for minimum discount.