WHAT DO I PUT IN MY PURCHASE AGREEMENT IF I WANT TO DO A SECTION 1031 EXCHANGE?

One of the most common questions we receive is something along the lines of "What do I put in my Purchase Agreement if I want to do a Section 1031 exchange?" The answer can sometimes be, "Nothing," although we do suggest that you use what is known as a cooperation clause. By law, there is no requirement for the cooperation clause. What is required, however, is that the contract be assignable, or in most states, that there be no restriction on the contract's assignability. In other words, your purchase agreement should not have language that says "This contract may not be assigned to another party by the buyer or the seller."

The reason for this is simple - in an exchange, the exchanger must assign the purchase agreement to the intermediary for the exchange to proceed. If a prohibition to assigning is present and it is not stricken from the contract, an exchange is not possible. What if you have already signed a contract that is so-restricted? As long as both sides agree, an exchange is still possible by using an addendum where the parties agree to allow assignments.

A more common approach is for the seller to lay his cards on the table and disclose to the buyer that he intends to perform a Section 1031 exchange by including a cooperation clause in the purchase agreement. There is really no downside to doing so when selling. By doing so, the exchanger establishes his intent and elicits the cooperation of the buyer. There is no loss of negotiating power when acting as the seller.

On the contrary, when a client has already sold his relinquished property and entered into an exchange, there can be a loss of negotiating power when offering to buy a replacement property. Let's assume that the exchanger has already formally identified three properties that could serve as his replacement property. For whatever reason, two of them are no longer available. (Perhaps they were sold to another party, or the seller took them off of the market, or one had a fire, etc.) Now the exchanger has but one property he can purchase to complete his exchange. If the purchase agreement contains language requesting the seller's cooperation for an exchange and the seller is savvy about exchanges, that seller may justifiably believe that he has the upper hand in any negotiations. That is why we often suggest that the exchanger leave out the cooperation language until after negotiations have concluded, instead having them make sure that the agreement does not restrict assignments. Then after the fact we can have an addendum added to the agreement that contains the cooperation language.

Now, what is this "cooperation language" that I've referred to so many times? Here is our version for when you are selling:

"It is the intention of Seller to transfer the above-listed property pursuant to Internal Revenue Code Section 1031, which sets forth the requirements for tax-deferred real estate exchanges. Seller's rights and obligations under this and future agreements will be assigned to Iowa Equity Exchange, qualified intermediary, for the purpose of completing an exchange. Buyer of the above-listed property agrees to cooperate with Seller and Iowa Equity Exchange in a manner necessary to enable Seller to complete said exchange. Such cooperation shall be at no additional cost or liability to Buyer."

Feel free to copy and paste this into your purchase agreements and get in touch with us whenever you are considering an exchange!