If you own a multifamily property in Los Angeles, chances are that you have received a call from someone like me saying “I am working with a Buyer who is in a 1031 Exchange who would like to purchase your building.” While there are certainly benefits to selling your property to an ‘Exchange Buyer’, they are not always the best option.
For those that are new to 1031 Exchanges, they are a tax loophole which allows property owners to sell an investment property and buy a replacement property of equal or greater value with the proceeds of the sale, while completely deferring any capital gains taxes that they otherwise would have had to pay if they did not purchase a replacement property. There are various other benefits to conducting a 1031 Exchange, which I will save for another time.
A 1031 Exchange Buyer HAS to Buy a Property or Pay Taxes
Perhaps what is most attractive about selling to a 1031 Exchange Buyer is the fact that the Buyer has to purchase a replacement property, because if they do not purchase a replacement property, they will risk paying capital gains taxes on the proceeds of the property that they sold (which depending on the deal can be millions of dollars).
A 1031 Exchange Buyer is on the Clock to Buy
Not only does an Exchange Buyer have to transact, but they are also under the gun to do so from a timeframe standpoint. An Exchange Buyer has 45 days from the close of their sale to identify a replacement property and 180 days to close on the purchase of their replacement property. So to recap, if you have your building on the market with multiple offers and there is an Exchange Buyer at the table, you know that a) the Buyer has to purchase something and b) he/she is on the clock to do so and c) in many instances Exchange Buyers are all cash Buyers. Sounds good right?
The Catch
The catch is that Exchange Buyer can identify up to 3 separate replacement properties and in some cases more than 3. As a result, sometimes Exchange Buyers will go into escrow on 3 different replacement properties with the intention of only purchasing one and cancelling escrows on the others. In addition, what is a pertinent piece of information to know about an Exchange Buyer is where they are in the process of the property they are selling. Ideally, they have already closed on the sale of that property and are in their 45 day identification window – but this is not always the case. Many times, Exchange Buyers are still early in the escrow process of their sale and in some cases have not even begun the sale process, in which case they are not even in a position to buy!
All in all, while your ears may perk up when you hear the term ‘Exchange Buyer,’ you must also beware of the risks.
