Can 1031 be used to paid down loan on your identified property?

[James Palassis]

I am under contract to purchase a property (closing set 8/4/21). Through a stroke of luck, I have a cash offer on one of my rentals (it's vacant due to a tenant turnover). 

I'd love to be able 1031 my sale and use the proceeds to pay for a portion of the property I have under contract. My concern is if the sale does not close before I have to close on the purchase. If that happens, can the proceeds from the sale be used to pay down the loan on the purchase (my identified property) if using a 1031 exchange? 

[Ashish Acharya]

Originally posted by @James Palassis:

I am under contract to purchase a property (closing set 8/4/21). Through a stroke of luck, I have a cash offer on one of my rentals (it's vacant due to a tenant turnover). 

I'd love to be able 1031 my sale and use the proceeds to pay for a portion of the property I have under contract. My concern is if the sale does not close before I have to close on the purchase. If that happens, can the proceeds from the sale be used to pay down the loan on the purchase (my identified property) if using a 1031 exchange? 

Yes, this can be done but needs to be carefully planned. @Dave Foster can probably help you on this. 

A reverse like-kind exchange (called a reverse Starker exchange) involves the purchase of replacement property by a taxpayer before the sale of the original property.

In Rev. Proc. 2000-37 (as modified by Rev. Proc. 2004-51), the IRS provides a safe harbor to facilitate reverse like-kind exchanges. These are sometimes called parking arrangements. A parking arrangement is designed to “park” the desired replacement property or the relinquished property with an accommodation party until the taxpayer arranges for the other steps of a simultaneous or deferred exchange to occur. The safe harbor provides that the IRS will not challenge the qualification of property as either replacement property or relinquished property, or the treatment of the accommodation party as the property owner under the like-kind exchange rules, if property is held in a qualified exchange accommodation arrangement (QEAA).

Property is deemed to be held in a QEAA if all of the following requirements are met:

• a. The qualified indicia of ownership of the property are held by a person (the exchange accommodation titleholder (EAT) who is not the taxpayer or a disqualified person and either such person is subject to federal income tax. If the EAT is a partnership or S corporation, more than 90% of its interest or stock must be owned by entities subject to federal income tax. The qualified indicia of ownership must be held by the EAT at all times from the date of acquisition by that person through the date the property is transferred. Qualified indicia of ownership include holding legal title to the property and may include beneficial ownership under commercial law, or ownership through an entity that is disregarded for federal income tax purposes.
• b. At the time the qualified indicia of ownership are transferred to the EAT, it is the taxpayer's bona fide intent that the transferred property be either replacement property or relinquished property in an exchange that is intended to qualify for nonrecognition under IRC Sec. 1031.
• c. No later than five business days after the transfer of the qualified indicia of ownership to the EAT, the taxpayer and the EAT enter into a QEAA that provides that the EAT is holding the property for the benefit of the taxpayer in order to facilitate an exchange under IRC Sec. 1031 and Rev. Proc. 2000-37. In the QEAA the taxpayer and the EAT must agree to report the acquisition, holding, and disposition of the property as provided in Rev. Proc. 2000-37. The QEAA must also specify that the EAT will be treated as the beneficial owner of the property for all federal income tax purposes. Both parties must report the federal income tax attributes of the property on their federal income tax returns in a manner consistent with the agreement.
• d. No later than 45 days after the transfer of the qualified indicia of ownership of the replacement property to the EAT, the relinquished property must be properly identified. Identification must be made in a manner consistent with the principles described in Reg. 1.1031(k)-1(c). This regulation generally calls for a specific description of the relinquished property in writing, signed by the taxpayer, and properly transmitted to the other parties to the exchange.
• e. No later than 180 days after the transfer of the qualified indicia of ownership of the property to the EAT, the property must be (1) transferred to the taxpayer as replacement property, or (2) transferred to a person who is not the taxpayer or a disqualified person as relinquished property.
• f. The combined time period the relinquished property and the replacement property are held in the QEAA cannot exceed 180 days.

The property will not fail to be treated as being held in a QEAA as a result of one or more of the following arrangements, regardless of whether the arrangements contain terms that typically would result from arm's-length bargaining between the unrelated parties:

• a. An EAT that satisfies the requirements of a QI under the deferred exchange rules may enter into an agreement with the taxpayer to serve as the QI in a simultaneous or deferred exchange of the property.
• b. The taxpayer or a disqualified person may guarantee some or all of the obligations of the EAT, including secured or unsecured debt incurred to acquire the property, or may indemnify the EAT against costs and expenses (for example, the taxpayer could guarantee to fund any negative cash flow generated by the property).
• c. The taxpayer or a disqualified person may loan or advance funds to the EAT or guarantee a loan or advance to the EAT.
• d. The property may be leased by the EAT to the taxpayer or a disqualified person.
• e. The taxpayer or a disqualified person may manage the property, supervise improvement of the property, act as a contractor, or otherwise provide services to the EAT with respect to the property.
• f. The taxpayer and EAT may enter into agreements or arrangements relating to the purchase or sale of the property, including puts and calls at fixed or formula prices, effective for a period not in excess of 185 days from the date the property is acquired by the EAT.
• g. The taxpayer and EAT may enter into agreements or arrangements providing that any variation in the value of a relinquished property from the estimated value on the date of the EAT's receipt of the property be taken into account upon the EAT's disposition of the relinquished property through the taxpayer's advance of funds to, or receipt of funds from, the EAT.