While a selling on contract for deed is usually a good method of seller-back financing because of the harsh and expedient enforcement mechanisms; if the Seller wants to defer 100% of the gains through a 1031 exchange, then it may be more advantageous to convey the Relinquished Property by deed and to take back a Note and Mortgage made in favor of CPEC1031 – Commercial Partners Exchange Company, LLC (the Qualified Intermediary or “QI”).
That way, prior to the purchase of the Replacement Property, the Exchangor can send the QI the outstanding amount due on the Note to buy the Note form the QI. Once the QI has all cash in the 1031 escrow account, all of the Exchangor’s equity (cash proceeds) from the disposition of the Relinquished Property may be applied to the purchase of the Replacement Property.
It is much more cumbersome to get the same result using a contract for deed because it requires the Exchangor to actually deed the Relinquished Property to QI, then the QI has to convey the Relinquished Property to Purchaser by Contract for Deed and later (just prior to the closing of the Replacement Property) the Exchangor has to purchase the contract back from the QI.
3 Rules of Thumb
There are three general rules of thumb to quickly see if you will defer all of the recognition of gain.
- Typically you will acquire replacement property that is “up or equal” in Value (price);
- You will roll over all of your Equity (net proceeds) from the relinquished property into your replacement property;
- And to the extent that you were relieved of liabilities and debt, such as mortgages on your old relinquished property, the debt relief is offset by (1) new liabilities or mortgages taken on in conjunction with your purchase of the replacement property; OR (2) by investing additional cash in the replacement property equal to the amount of liabilities and debts that were discharged.
Generally, people prefer not to put the QI into the chain of title and want to avoid the extra costs and recording fees that may entail. A Note and Mortgage are just an easier form of seller-back financing when you are loaning your buyer money on the sale of your Relinquished Property and also trying to juggle the requirements for 1031 exchange perspective.