1031 - If you sell a house on contract how does a 1031 work

[Rylan Zwanziger]

Curious as to how a 1031 exchange works when selling a house on contract.  If I sell a house on contract when does the 1031 exchange actually take place?  

[Dave Foster]

@Rylan Zwanziger, selling a house under a land contract where you collect payments but title doesn't transfer until all the payments have been made is a tricky situation for a 1031 exchange.  

By statute the 1031 starts with the sale of your old property and you use the proceeds without having constructive or actual receipt of them to purchase your new property.  In a land contract you might think that means that you can wait until the title transfers and that is when the sale occurs.

Unfortunately a couple of things come into play.

1. There is a legal concept called "risk of loss passing" which describes the actual transfer of property happening when the risk of loss has substantially passed to the buyer or when the buy has received the benefits and burdens of ownership.  In a land contract that usually happens that the signing of the contract even though payment is not rendered.  

2. Receipt of funds - Along with that you are receiving monthly proceeds in payment for the property which would normally be separate from you in an exchange account.  In a land contract you touch the money so it would become taxable as boot to you immediately anyway.

3. Time frames - The entire period of a 1031 can be no more than 180 days.  Most land contracts are set up for years.  

Depending on your individual situation there might still be a way to structure the land contract to work with a 1031 but it's difficult.