is 1031 exchange possible if I seller finance?

[Kevin Turano]

hello, If I am the owner and sell a property by owner financing it / carrying the note; can I still do a 1031 exchange?  For example, lets say that that I own property and buyer pays me $50,000 and i finance $50,000 over 20 years.  How is this handled?  Is this typically bad for tax strategy?  Please advise.

PS- If i take that $50,000 down payment and purchase a rental property with in 180 days can that be a 1031 exchange?

[Bill Exeter]

Hi @Kevin Turano, 

Yes, it can be done but it gets more complicated.  The cash and the seller carry back note ("SCBN") are the "net proceeds" from the sale of the relinquished property.  The cash and the note must somehow be used toward the purchase of your replacement property if you want to indefinitely defer all of your taxes.  

The best practices approach is to have you act as the bank.  You would fund the SCBN through the closing by deposited $50,000 into the closing.  The SCBN would be drafted in your name as the lender.  The closing would have the full $100,000 in cash so that you can easily proceeds with your 1031 Exchange.  

Many investors do not have sufficient capital to act like the bank and fund the SCBN, so the SCBN would be drafted in the name of the Qualified Intermediary and upon closing of the sale of the relinquished property the Qualified Intermediary would be holding $50,000 in cash and $50,000 in a note.  The cash and the note would then have to be used somehow to acquire replacement property within the 180 calendar day exchange period. 

There are really three options here: 

1. You can "buy" the note out of your own 1031 Exchange after closing (but before the replacement property closes) so that you have all cash in your 1031 Exchange.  Again, many investors do not have the capital to do this. 

2. You can sell the note to anyone to create liquidity, but note buyers generally want a pretty steep discount. 

3. You can find a replacement property where the seller is willing to accept an assignment of the SCBN as part of the payment for the property.  The seller would end up receiving the $50,000 in cash and the $50,000 SCBN.  Most sellers will not touch a third party note, but there are some more sophisticated sellers and brokers that will do so. 

The best advice is to try not to sell with a SCBN, but if you must to get the deal done, then the above would apply and takes extra planning.