1031 and owner financing

I was wondering how owner financing effects putting a property into a 1031 exchange. Can you do an exchange if you are carrying a mortgage on the property? Is just the value received put in the exchange and the mortgage considered boot? Thought this topic might be interesting from both sides of the bargaining table, helps to know your selling and buying options.

Howdy beggyone:

From what I have read the owner financing will not effect the 1031. Boot is only when you keep some of the cash received or buy a cheaper property than the one surrendered. I hope Dave will answer and give us some of his wisdom and correct me if I am wrong.

There is a way to do a fully tax-deferred exchange with seller financing through your qualified intermediary. You deed your relinquished property to the intermediary, and assign your sale contract to the intermediary. The intermediary conveys your property and receives a note and perhaps some cash. The intermediary sells the note in the secondary note market (most likely at a discount), then uses the net proceeds of the property sale and the note sale to acquire your replacement property. To close the exchange, the intermediary conveys the replacement property to you.

Remember, a 1031 exchange involves like-kind property. When you exchange your relinquished property for your replacement property, you have done a like-kind exchange – real estate for real estate.

If at the end of the exchange, you end up holding real estate and a note, then you have received NOT like-kind property. The value of the note you are holding will be taxable boot. If the note is of any significant size, you may completely negate the tax-deferral benefit of the exchange.

Thanks Dave, Your explanation was something like I was thinking but its always good to have more precise info. I was having a hard time with getting the note into the exchange and out. I don’t see the advantage if I was the seller doing an exchange.