Since a note typically represents equity in a property, and a 1031 exchange requires all equity to be carried forward, it is necessary to carry a note in an exchange to defer all of your taxes! Watch for more on NOTES in an exchange from the best self-directed 1031 Exchange Facilitator out there, David Moore.
1031 Exchanges: 5 Ways To Carry a NOTE In An Exchange
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Notes, a lot of people say, “Well gee, you can’t carry a note on an exchange.” Totally untrue. Five ways to do it.
So, the note, remember we talked about consideration on transaction. The property sells, the cash comes in, which is not like kind. The note’s not like kind. You get a boat. That’s not like kind. Whatever the consideration is, it’s not like kind, unless it’s a house, unless it’s something that is like kind. So when we’re looking at these things, the note represents, typically represents, equity in a transaction. Does it always? Have you heard of a wrap? A wrap contract is an underlying first with a second there that wraps the first. That’s a wrap. Can we do an exchange between a wrap? Yes, we can, alright? Gets complicated.
If we’re looking at just a first, and we want to sell and carry the buyer, a lot of times you’ve got a tenant that wants to buy the property. I will warn you, and some of you, if you’re in the mortgage world know more about it than I do, but the deal is, if you’re selling to somebody and it’s their home, you’ve got a higher standard there. You’ve got to be a licensed loan originator to draw that note. So be careful with that.
If it’s just an investment property for someone, go get the Stevens Ness form. Use that. Let escrow draw it, whomever. But if it’s owner-occupied, just make sure you talk to your tax or legal people, actually. You cover your tail. Make sure you don’t do something that could get you in trouble. So owner-occupied, it’s different than not owner- occupied.
Owner-occupied, the tenant is the owner?
David Moore’s Answer:
If you’ve got a rental house, your tenant wants to buy the property, you’re going to carry them. You better have your lawyer, somebody that’s a licensed loan originator to draw that note. If it’s an investor, then it’s different.
The owner shouldn’t? Right?
David Moore’s Answer:
How do you know if it’s sale. Might be the first investment.
David Moore’s Answer:
Yeah, we just need to know. I mean, if it’s your tenant, you know they’re going to live there, right? I mean, that’s the typical scenario. The note comes unto us. We have to do something with the note. We can not use the note to acquire something else, so we can use the note, in cash, to buy a replacement property. It doesn’t happen very often, but it could happen.
One, we could sell the note to a third party. [inaudible 00:02:26]. I don’t know why. I mean, if you’ve put money in the bank today, you get nothing. Seems like notes would be worth something to sell them, but it’s still not.
We can use the note in cash to buy something. It rarely happens. Purchase a note. What do I mean by that? Our client buys a note, and you’re saying, “Well gee, it’s my note.
Why would I buy the note from you?” What you’re really doing, is substituting cash for the value of the note. By doing that, if you’ve got a half million dollars sitting in the bank, what are you making interest-wise? Nothing. Right?
If the note’s paying five or six percent, where else are you going to get five or six percent today, comfortably? This is an asset you know, and it can give you a nice cash flow.
What are you going to do with the money, if you don’t do it? Just be aware, carrying the thing like I said, debt relief and appreciation recapture in the year of sale. Just make sure you know that, if you’re going to carry paper.
We have a lot of times, our client’s going to buy the note from us. Short term note. Why is the note there? Maybe the thing’s not completed. Maybe it’s got little required repairs. They can’t finance it, so they want you to carry them, short term, 30 days, 60 days. Later, a permanent financing comes in place, or maybe, they’re up against their 180th day on an exchange, or maybe you’re in a situation where, it’s a reverse, and you’re up to it.
That note comes in. Think of a reverse exchange with a note. Reverse exchange, we don’t really go into details, but a reverse exchange, you have to have the financial ability to buy a property today, to replace something yet to be sold. Whatever you come in with, money wise, to buy that property, we have in effect, borrowed that money from you. You show up and ask for $100,000.00, and to go buy that property. Now you sell, and you carry, so all these things are aimed at, like in a delayed exchange, this note coming in to having to do something with it.
If we’re in reverse exchange, and you carry a note, now that note comes into us, we can use the note to repay the debt we have got to use. A note … A seller carry back and reverse is actually, a nice, easy thing for us to deal with.
Why is the note there? We just wait until it blooms, complete the acquisition replacement of five partial exchange. Maybe the down payment’s enough, and maybe just apply, and you pay tax on the balance of it. That’s fine. You can do that, but anybody that says you can’t do an exchange, carry in a seller carry back, totally wrong. There’s five ways to do them right there, and it’s something that we do all the time.