Many taxpayers conducting a 1031 exchange have questions about bank financing in a 1031 exchange transaction. Here are a few tips and things to know when it comes to bank loans and 1031 exchanges.
Bank Loan Agreement
The banks’s loan agreement may require the exchangor (through the intermediary) to exhaust the 1031 funds for the purchase of the replacement property and for the first construction draws before the banks loan funds will be disbursed. The bank cannot take a security interest in the 1031 funds held by the intermediary.
The taxpayer conducting the exchange may co-sign or provide a personal guarantee of the bank’s loan.
The ‘due on sale clause’ in the loan may need to be modified to allow for the transfer of the replacement property to the exchangor during the 180 day exchange period.
Depending on the number of exchangors, the 1031 exchange may be completed by:
- deeding the replacement property from the LLC to the exchangors (with a corresponding mortgage assignment/assumption); or
- by the intermediary assigning 100% of the membership interest in the LLC to the exchangor (which may negate the need for a formal mortgage assignment/assumption).
Items to Request
In a 1031 exchange with bank financing, you should request the following items:
- Prior Exchange Documents.Copy of the signed relinquished property 1031 documents from the sale with confirmation of the amount of funds held by the intermediary (we need to confirm who and how the old relinquished property was vested in title). The 1031 identification of replacement property should include a description of the new land plus the to-be-built improvements.
- Fresh LLC to hold title to the Replacement Property.Copy of the LLC articles, certificate of organization, operating agreement and authorizing resolution appointing the officers (this LLC will likely be 100% owned by the intermediary);
- Title Commitment for the new Replacement Property.
The loan documents may need to be modified to limit the liability of the intermediary.