Is 1031 exchange possible with seller financing?

[Ray Hage]

Hi BP family. I put up one of my properties for sale and I received a verbal offer that I liked but the agent is asking if would be willing to accept 20% and interest only financing for 2 years. The buyer would then refinance before the 2 years is up. Frankly, I would be ok with that except for one thing that I am unsure of. Am I able to 1031 exchange any of the money (the 20% down payment?)  into another property to avoid the federal capital gains tax? 

[Dave Foster]

Thanks for those kind words @Ash Hegde.  @Ray Hage, It can be done.  But there's some nuance.  In order to defer all tax in a 1031 you must purchase at least as much as your net sale and use all of the proceeds from the sale in your purchase.  Since the note and the downpayment are all proceeds you must use all in the purchase.  That creates a problem since the seller will probably not want to accept the note from you as part payment.  

The answer is to find cash from some source (any source) and swap the note in your exchange account with cash.  Then you'll have enough cash in your exchange account to complete the 1031 completely tax deferred.  

And outside the exchange you'll have to note which is not non-taxable except for the interest.  So when that buyer refinances and pays you off in two years you won't have a tax bill then either.