Alexandra L. Hart, CES® at All States 1031 Exchange Facilitator, LLC has been asked several times recently about how to buy replacement property at an auction. While there is certainly nothing in section 1031 that specifically prohibits or disqualifies such replacement property, the real problem lies in the process and logistics of the auction process. Most of the auctions are being held in connection with a mortgage foreclosure.
At most auctions, the bidders must show a certified check in a certain minimum amount, such check being evidence of the ability to make a deposit payment. Other than proof of ability to pay, and proof of identification, very little is required. Standard purchase and sale agreement are not typically used. The issues affecting the 1031 exchange include meeting the identification rules, assignment to the qualified intermediary of the right to buy the replacement property, and potential constructive receipt and boot issues.
In many auctions outside the 1031 arena, the bidders will bring a certified check payable to themselves. If they are the successful bidder, they will endorse the check to the seller or the auctioneer. In the 1031 world, if the QI issues a certified check payable to the exchanger, and then the exchanger endorses the check to the auctioneer, the IRS will likely assert that such amount was received by the exchanger and taxable as boot. Furthermore, the payment could possibly disqualify the entire exchange as a distribution in violation of the specific restrictions (known as the g(6) limitations (see Treasury Regulation Section 1.1031(k)-1(g)(6)) on payments from the exchange account. In other words, issuing a check payable to the exchanger is not a good idea.
One alternative is, prior to the auction, ask the auctioneer for the name of a title company they trust and have the QI place the exchange funds with them subject to the acceptance of the bid. The exchanger can take blank assignment of contract documents with them to the auction to be executed in the event that they are the successful bidder.
Another alternative is to have a certified check issued by the QI to the auctioneer to be used in the event of a successful bid. Otherwise, the check is returned to the QI.
Or, if the exchanger is trading up in value, the exchanger can use his or her own funds.
Other solutions could be found in particular situations. If you are contemplating purchasing a replacement property through the auction process, be sure to contact Alexandra L. Hart, CES® or F. Moore McLaughlin, Esq., CPA, CES® to determine the best alternative. You can reach Alexandra at AHart@AllStates1031.com or toll-free at 1-877-395-1031 extension 217.
Tags: 1031, 1031 exchange, All States, auction, bankruptcy, capital gains tax, Certified Exchange Specialist, CES, complimentary 1031 consultation, deed in lieu of foreclosure, foreclosure, investment property, IRS, Moore McLaughlin, QI, qualified intermediary, qualifying property, short sales, zero equity