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