An Exchanger who elects to carry back a note on a relinquished property in a 1031 exchange has two basic options to treat the note:

1. DO NOT include the note in the exchange and pay any taxes that may be due

The Exchanger would receive the note as the Beneficiary at the closing and pay taxes on this portion of the capital gain under the Installment method (as specified in IRC §453). In this option, the note is made payable to the exchanger and is received by the exchanger at the closing of the relinquished property. The drawback is that capital gains taxes could become due in one lump sum if the note allows for prepayments or if a balloon payment is required.

2. Include the note in the exchange by initially showing the qualified intermediary as the beneficiary and possibly defer the capital gains taxes

This option gives the exchanger four alternatives to try to use the note as part of the tax-deferred exchange. To avoid “constructive or actual receipt” by the exchanger, the intermediary is named as the beneficiary on the note. The alternatives are:

(A) Put the note toward the down payment on the replacement property purchase. If the Seller accepts the Note as partial payment toward the purchase price, the Intermediary assigns the Note to the Seller and delivers it at closing.

 (B) Exchanger purchases the note from the intermediary. Made during the exchange period, this can allow the intermediary to use the note’s proceeds for the purchase of the replacement property. Purchase of the note from the intermediary may include a discount to represent its fair market value at the time of purchase.

 (C) Pay off the note before closing on the replacement property. Done during the exchange, this works only on short-term notes due within the 180-day exchange period. The payer pays off the note directly to the intermediary, who holds the note and adds the payoff to the existing proceeds in the qualified exchange account. When the replacement property is ready to close, all proceeds are delivered to the closing officer.

 (D) Sell note on the secondary market. This replaces the note with cash, which is added to the qualified exchange account for purchasing the replacement property. Typically, the Note will be sold at a discount, and the discounted amount may be considered a selling expense.

Many exchangers choose Option 2 because it allows for several tax-deferral alternatives without penalizing the exchanger. If none of the alternatives is successful, the intermediary can assign the note back to the exchanger, who will have all the tax benefits available through Option 1.

This is for educational purposes only, does not constitute an offer to buy/sell securitized real estate investments, and is not meant to be interpreted as tax or legal advice. Because investors situations and objectives vary this information is not intended to indicate suitability for any particular investor. Please speak with your legal and tax advisors for guidance regarding your particular situation. Securities offered through Concorde Investment Services, LLC (CIS), member FINRA/SIPC. Advisory services offered through Concorde Asset Management, LLC, an SEC registered investment adviser. Insurance offered through Concorde Insurance Agency, Inc. Fortitude Investment Group is independent of CIS, CAM and CIA.

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