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Related Property and Owner Finance

Related Property 


You may exchange property with a family member or your own corporation, but there are certain rules that you must abide by or the exchange could be disqualified and the transaction could become taxable. If you directly or indirectly own 50% or more of a limited liability company (LLC) or a corporation or partnership, that entity would be considered a related party.  Any immediate family members are related parties, and include siblings, spouse, ancestors and lineal descendants.  An executor of an estate and the beneficiaries of the estate are considered related; but two trusts, one created by the husband and one created by the wife, are not considered related persons.

If you do a related-party exchange, the property acquired must be held for no less than two (2) years before it can be sold or exchanged in order to not void the exchange.  This applies to both related parties in the transaction.  This two-year holding period may be waived if it is established to the satisfaction of the Secretary of the Treasury, or his delegate, that the subsequent disposition was not for the purpose of tax avoidance.


OWNER FINANCING IN A 1031 EXCHANGE


When relinquishing a property in a 1031 exchange, the exchanger is often asked to carry back part of the purchase price in the form of owner financing.  If the exchanger receives a Promissory Note and Deed to Secure Debt or Trust Mortgage, it is considered boot and is taxable.  To avoid this result, the Promissory Note may be drawn in the name of the Qualified Intermediary (QI).  The Note may be handled in two (2) different ways:

First:  The Note may be sold by the QI in whose name the Note was drawn.  At the closing of the relinquished property, the Note is delivered directly to the QI along with the sale proceeds.  Any Note payments due will be paid to the QI.  The Exchangor and/or the QI find someone to purchase the Note.  Usually the sale is at a discount.  The sale proceeds and any payments received during the holding period are deposited into the Exchangor’s account and combined with the sale proceeds.  The funds are then used to purchase the Replacement Property.  If a buyer for the Note cannot be found during the time restraints for concluding the exchange (180 days) and the money or sale proceeds are received after the 180 days allowed is concluded, the money received will be considered Boot and taxable.

Second:  Have the Seller of the Replacement Property take the Note as part payment of the Replacement Property.  The Seller of the Replacement Property then receives the payments as provided for in the Note.  The property sold or relinquished may secure the Note, and the Exchangor may also act as a guarantor.