Recently I spoke with a mortgage office about 1031 exchange basics and the circumstances where they would typically see one. Here’s a quick read for those new and old to the mortgage industry.
1031 Exchange Basics
Who: Individuals, trusts, partnerships, corporations both domestic and foreign are eligible for the tax deferral.
What: Real property held for investment or for use in a business are eligible for 1031 consideration. Property is sold and replaced. Real property can be replaced with any kind of real property. U.S. can be replaced by U.S. based property while international property is replaced with international property.
Why: A 1031 exchange enables the titleholder to defer federal and state capital gains and recaptured depreciation taxes representing upwards of 40% upon sale of the old property.
When: The tax deferred exchange must be signed prior to or at the closing of the first property. The Exchangor must complete their tax deferred within 180 calendar days post the first closing.
How: The use of a qualified intermediary is required to effect a 1031 exchange, except in a two party or “pure” exchange. Given the moderate intermediary fee, it is well worth an accommodator facilitate the exchange.
Forward and Reverse 1031 Exchange
There are two primary types of exchanges, a forward and a reverse. Forward exchanges are when the old or relinquished property is sold first followed by the acquisition of the replacement property. In a reverse, the replacement property is purchased first, with 180 calendar days to sell the old property.
Here’s where you come into the transaction. The Exchangor needs to acquire the replacement property first. In a reverse 1031 exchange, the Exchangor is not allowed to own both the new and the old at the same time. The qualified intermediary creates an Exchange Accommodator Titleholder (EAT) in the form of a single member limited liability company to take title to either the new or the old property for the duration of the 1031 exchange.
If the EAT takes title to the new property that the Exchangor is financing with you, the EAT signs a non recourse note, guaranteed by the Exchangor. Payments continue as normal with the EAT temporarily on title. The Exchangor signs a triple net lease with the EAT to cover insurance, taxes and expenses of renting the property. Once the old property is sold, title for the new property is transferred to the Exchangor.
If the EAT takes title to the old property, the new property financing continues as normal. With the EAT on title to the old property, mortgage payments continue to be paid by the Exchangor. The property is marketed and sold with the Exchangor signing the settlement statement under “Read and Approved” while the EAT signs as the Seller. The 1099 bears the name and address of the Exchangor.
If the old property fails to sell, the property parked with the EAT is conveyed to the Exchangor by the 180th calendar day.
Many of my referrals come from mortgage brokers seeking a seasoned qualified intermediary to accommodate reverse 1031 exchanges. If you have a question, feel free to reach out via the links above, or call our office at 1-800-227-1031.
