Can I Do a 1031 Exchange on My Contract for Deed Balloon Payoff?

(Listen Here 3:13 min)

Contract Deeds or Executor Contracts, basically installment sales, create a lot of questions. Here is one that I get a lot. I sold my property ten years ago on an installment sale, a Contract for Deed. And now, I am being paid off, and I am getting this balloon payment from the buyer. Question: Can I do a 1031 Exchange on this windfall of cash that I am receiving?

Understand the Timing -  When Did the Sale Take Place

 If you look at this transaction, it may appear that the sale is now occurring because when the balloon payment is given to the vendor, the deed will be delivered to the vendee. So, it feels like perhaps the sale is occurring now. But, for Federal Tax purposes, the sale probably occurred ten years ago when the Contract for Deed or the installment sale was entered into.

Who is Really the Owner of the Property

When a Contract for Deed is given, the purchaser or vendee is considered to be the equitable owner of the property. They probably bear the risk of loss if the property is destroyed. They probably bear the burden of paying the property taxes to the local property tax assessor. And, under the contract, they probably enjoy the possession, the exclusive use of the property. So, for Federal Tax Purposes, the Contract for Deed vendee probably acquired the property way back when the initial Contract for Deed was entered into. Now, when this windfall is coming in, we are not really selling the property anymore, we are just receiving payoff like any other lender who has loaned money to a purchaser.

Section 1031 Does Not Apply to “Evidence of Indebtedness”

When a Contract for Deed vendor holds that legal title, they don’t necessarily own the property anymore. They really own an enforcement mechanism. In the event of a default under the Contract for Deed, they can swoop in and cancel the Contract for Deed. This is an enforcement mechanism much like a mortgagee’s interest or bank’s interest in a mortgaged property. They are really a creditor, not so much a property owner for Federal Tax Purposes.

About the Author:

Jeff Peterson (AKA: "Professor 1031") is a Qualified Intermediary and Serves as an Adjunct-Professor for the William Mitchell College of Law (Where He Teaches About Federal Income Tax). Jeff Works With People From All Over the USA to Save Money on Federal Capital Gains Taxes.

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