Combining Seller Financing and a 1031 Exchange

[Lawrence S.]

I am seeking to exit from real estate by way of seller financing.  The properties were originally retail and office, but most recently are apartments, so I assume there is recapture of depreciation (not sure if that is section 1245 or 1250).  In any case, alot in taxes would be owed.  And what I am seeking to accomplish is to get out of real estate.  And I had the following questions:

1) If you seller finance and the buyer defaults and they don't cooperate with you, are you still going to be able to complete the exchange process.

2) To know the buyer is serious I will want a serious down payment.  But I don't even want to receive all of that at once.  Can I set time frame(s) during which the money is received (100K a year, for example) by having a exchange accomodator hold the money,etc.  Or would that violate the 180 day rule?

3) Can I stagger the balloon payments?  Such as having a ballon every year for 100K until it is exhausted.

4) If, when I am entitled to receive the funds, if I instead want to 1031 the balloon into another property, can I do that?

5) What I am trying to do is to gradually receive the funds, but I'm not sure how to accomplish that.

6) I have heard a suggestion to do multiple 1031s and receive a certain amount of cash year, but that would be alot of work since I would have to buy 90% of my current assets, then the next year 80% of my current assets, etc.

7) I don't really trust the TIC and/or DST (Delaware Statutory Trust) type properties, so I tend to think of this as the most likely resolution.

8) Since some of these properties are triplexes, some would be classified as residential.  Although I could combine them so they are all commercial.  In terms of prepayment penalties I have heard some commercial brokerages will do a penalty like 5% 1st year, 4% 2nd year, 3% the 3rd year, 2% the 4th year and 1% the 5th year.  Will that complicate the transaction?

Thanks.  Any suggestion appreciated.

[Daniel Dietz]

@Dave Foster, let's see if I am understanding what you are saying about 'replacing the note with cash' in a 1031.

Let's say I have Property #1 that I want to sell with Owner Financing for 400K. I took 100K depreciation and have 100K in appreciation, so let's say 25K in recapture tax and 20K in capital gains tax due. 

I sell Property #1 for 40K down as 'boot' to cover the recapture tax (40K - taxes + 25K) from the buyer and he/she also brings a bank loan for 180K and I carry 180K of seller financing over 20 years. 

Now enter Property #2 that I own. I do a cash out refi to get 200K from it (or it could come from other sources for that matter) and I put THAT 200K into the 1031, and take the seller financed note for 200K out in exchange for it. 

I then take the 360K and reinvest that into a new property, and still have the 180K seller financed note which is now 'outside of' the 1031 and collect payments over time? I assume that this would then be taxable with the interest portion as ordinary income and the principal payments would be taxed on 25% of that payment (the same as the ratio at sale time of property #1)? 

@L S. It sounds like you have multiple properties to sell maybe? Can you spread the sales over a number of years to help you achive your goals?

Dan Dietz