Buying Subject To with 1031 and Escrow?

Question

Hello,

I'm looking to sell a rental in TX and buy a new one in Idaho Subject To sellers existing loan. I would use proceeds of TX sale to pay the seller his equity leaving just his loan. I've been told by 1031 accommodator it would be an All Inclusive Deed of Trust where the seller has a note with me for the same as his loan balance. The home I'm looking at is on market with a listing agent. Can I go through a normal escrow process, or would I have to do a Grant Deed, Quit Claim Deed or something and just get it recorded at the county on my own without escrow because the loan would not be paid off during escrow? Not sure if the agent would want seller to go that route. Trying to figure out best way to move forward. Thanks, Clint

Kerry Baird · Answer

You are mixing up deeds and a “deed of trust.”  Deeds convey ownership.  The deed will be notarized and subsequently recorded by the title company.  Once that is done you have ownership.

That deed (warranty deed, quit claim deed etc) has nothing to do with the mortgage, which is what the AIDT you reference actually is.  A “deed of trust” is a mortgage instrument but does not convey ownership.  Since you are taking over the mortgage, subject to the existing financing, you most likely do have the property taxes and insurance escrowed.  I would get a specific power of attorney to handle any insurance or property tax concerns.  You ought to close with an attorney or a title company and ensure these pieces fall into place as you expect them to.

Angela Yan · Answer

@Clint Nunes

Hi there Clint!  Thanks for posting this scenario as i am about to be in similar situation. Can you shine a light as to how you pan out? Did you end up doing the 1031 exchange with a subject to deal? If so, how did you go about it? Tittle company and escrow service? What sort of contracts were at play?

Really appreciate any insight. Best of luck!

Bill B. · Answer

If you go ahead with this. Make sure you have the amount of the seller’s loan lying around in cash or can get approved for a new loan within 30 days.

If the seller’s bank finds out the property has changed hands they will probably want to get their money that’s earning below market interest back in their hands to lend out again at a higher rate. This means calling the loan and giving you 30-60 days to pay them in full.

Otherwise you risk losing any cash you put in to the deal (plus owing all the deferred tax from your 1031.)The seller probably won’t lose too much if the bank put the property up for sale to collect their loan. You might even be able to give the property back to the seller if they want it back.

People will say the banks never call a loan due on sale. But for the last 20 years they were being paid above market interest in these loans as interest rates fell. This is the first time in most people’s investing lifetime they have an incentive to call them due.

Dave Foster · Answer

@Clint Nunes, As long as you're purchasing at least as much as you sold (including your cash down and the assumed loan) and using all of the cash from your sale.  This could be done.  the key is that your accountant has to agree that "risk of loss" has passed from the seller to you sufficiently.  With a large enough down payment and well written contract this could be enough even though deed is not passing.

You may not be able to convey title via quit claim as long as that loan is recorded against it.  And if you do it could trigger a due on sale.  But the mechanism works.

Clint Nunes · Answer

@Chris Davidson - Thanks for the reply Chris. Yes it sounds possible to take title, but then the possible due on sales clause where they could call the note due basically negating all of the effort and benefits of going this route. I haven't sold the TX home yet and am willing to pay "rent" to the seller until it sells so he's not out of pocket while waiting for mine to sell.

I'm just trying to find the best path to move forward. Take title and risk due on sales clause, or don't take title and just have a contract showing that its mine which may get complicated since I've never done that approach.

Dave Foster · Answer

@Clint Nunes, ownership is all about how it is reported on your tax returns.  A subject to situation is similar to a land grant is similar to a long term lease of real estate of more than 30 years.  In all cases a deed does not convey.  But it is treated as real estate for 1031 and for tax reporting.

In your case the key is get the consensus of your legal team or accountant that "risk of loss" has passed from the seller to you.  Another term for this is that the "burdens and benefits of ownership" have passed from the seller to you. In other words you are responsible for the property.  You have the risks of owning real estate.  And if it makes money it's to your benefit.  And if it loses money it's your loss. A deed doesn't convey.  But the property is deemed to be yours even though the deed is still in someone elses name.

This is not an uncommon occurrence.

Clint Nunes · Answer

@Dave Foster Thanks for the info. I think it can work on the 1031 side, but I would have to take title somehow and I'm not exactly sure if that could be processed in with a title and escrow company since the loan isn't paid off. I've never heard of a 1031 happening where title isn't transferred. Is that something that can be done? I guess we wouldn't benefit from interest or property tax write offs if title isn't in our name though.

Clint Nunes · Answer

Hi Bill, You bring up some very good points. I'm aware of the due on sale clause and we would be putting down about $250k from the sale to make the numbers work and I would hate to give that up and lose the house too. I wish I knew how likely the due on sale clause could happen.

Clint Nunes · Answer

@Angela Yan

That property didn't go through. We couldn't find an attorney in ID that understood the deal we were trying to do and sellers went with another offer even though it was quite a bit lower than ours. I'm still searching. Pace Morby does a lot of Sub To deals and has a bunch of info on Youtube and podcasts. Lots of people in the forums do a joint venture with his students to get the contracts and help source a title/escrow company that understands the process. I'd start there. It'll be a bit different for each state.

Chris Davidson · Answer

@Clint Nunes Ideally you are entering with a decent bit of equity from the 1031, which should allow you to refi if they call it. It is unlikely that they will but if so just make sure the deal is doable with current rates. If the deal works ok with current rates, and great with existing loan great move forward.

Sounds like it is a good deal if you are willing to pay for it before you own it. Roll the dice and may they be in your favor!

Buying Subject To with 1031 and Escrow?

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