1031 Exchange to Seller Financing

[Dominique Coffin]

Looking for some insight on the topic of doing a 1031 exchange into properties that the owner would want to do seller financing. Does anyone have any experience in this? Looking for certain things I need to watch out for or any advice that would help. Thanks in advance!

[Bill B.]

Talk to @Dave Foster. Doesn’t sound impossible. As logn as you give seller every dollar you receive in “cash” from your sale as a downpayment. Otherwise any cash you keep would be taxable.  usually the problem is when a seller wants to do a 1031 but the buyer wants seller financing. That’s basically impossible unless seller is sitting on replacement cash. 

[Sean Ross]

Quote from @Dominique Coffin:

Looking for some insight on the topic of doing a 1031 exchange into properties that the owner would want to do seller financing. Does anyone have any experience in this? Looking for certain things I need to watch out for or any advice that would help. Thanks in advance!

@Dominique Coffin,

This is much more common in our current interest rate environment. 

There are a lot of possible issues with seller financing while doing a 1031.  It's possible!  But you want to be careful.  A direct attempt at seller financing will result in taxes being recognized for the value of the carryback note (making the exchange less efficient). The carryback note is not considered a valid asset to receive in an exchange. For example, if you sell a $750K property with $500K in seller financing...well, the $500K will be excluded from the exchange and capital gains taxes will be recognized as payments are made.  Even worse, all of the depreciation recapture taxes allocable to the $500K will be recognized and due in the year of sale. 

(There are even some who believe that the seller providing a loan to the buyer will disqualify the exchange entirely, but that's not been our experience.)

The most straightforward solution is to have the seller provide a cash loan to the buyer outside of closing.  This way the buyer can come to closing with all of the necessary funds to allow for a normal 1031.

  If the seller is not liquid enough to provide a loan, they could attempt to find another financing option for the buyer.  If this doesn't work, then the seller can have the carryback note made payable to their 1031 Qualified Intermediary.  The Intermediary can then sell the note to any party, including the seller or a seller's family/friends.  Any proceeds from the sale of the note can be added to the 1031 exchange account to allow for more tax deferral. 

The issues get a little deeper, but the key takeaway is that careful planning is very, very important.  A lot of my company's clients are trying to do this in 2024, with mixed results. 

Happy to answer any questions you have. 

[Dave Foster]

@Dominique Coffin, The seller finance acts just like a loan from any other source.  You're just borrowing from the seller instead of the bank.  Like @Bill B. said, as long as you are purchasing at least as much as your net sale.  And you are using all of the proceeds from your sale as the down payment you will defer all tax.

On the other hand - if you're wanting to sell your property and carry the note back as seller financing to the buyer you will either pay the tax on the note (but it will be an installment sale and so the tax will be spread out).  Or you will have to have cash to replace the note in your exchange account.  So you can move forward with all cash.