The 1031 exchange is more flexible than it may appear at first glance. As an instrument for deferring capital gains taxes and depreciation recapture while exchanging real estate for new properties of equal or greater value, it has been around for nearly a century and has continually evolved to meet needs of investors. Its reputation for tight deadlines and many rules with strict enforcement is well deserved, however, and you will encounter the intersection of strict rules and flexible application when you acquire a 1031 exchange property at auction. Although a transaction of this type is risky, it is possible.
How to Use a 1031 Exchange Property Acquired at an Auction
The first challenge in acquiring 1031 exchange property at auction is finding a qualified intermediary (QI) that is willing and capable of working with you. The task will be a demanding one for your QI, so choose carefully. Together, you’ll need to create a detailed plan of action before the exchange, so that the QI can function properly and within the parameters of a 1031 exchange.
Auctions can be divided into two categories: those conducted by auction houses and those conducted by a bank, sheriff, or other party in a distressed property settlement.
The first case is fairly simple. Many auction houses are prepared to handle 1031 exchanges. They may be willing to adjust the payment period, which is characteristically very short—usually no more than 48 hours—to allow the QI to draw up the necessary documents and a check. Otherwise, they may accept a large check in advance with the understanding that they will refund the portion not spent on your winning bid or the full amount if you do not have the winning bid. This reliability and accommodation will not be present in a bank auction.
Banks Auctions Are More Difficult
Since there are many easier ways to use the 1031 exchange than acquiring property through a bank auction, you’ll likely only do so with a specific goal in mind. Even if the goal is no more than to “get a good deal,” choosing specific properties to target at auction allows you to overcome one of the biggest risks associated with the transaction: missing the 45-day deadline for identifying replacement properties.
Many times, a property scheduled for bank auction never makes to the bidding stage since there are numerous ways the property owner can delay or prevent the action. By timing your 1031 exchange to make sure the property you are targeting is auctioned off (or planned to be auctioned off) well within the 45-day replacement selection period, you allow yourself time to react to possible failure. If the auction does not take place or you do not win it, you still have time to select another replacement property. While you are not prevented from selecting an auctioned property within the 45-day deadline and bidding later, you risk the failure of the entire exchange if the auction does not go as you expect then.
Additionally, you must know the rules of the auction in advance to plan correctly. You may need to pay 10-20 percent of the sale price on the spot, or you may have to pay the full amount. Most QIs will not cut a check on the spot without the necessary exchange and property closing documents completed. As a result, it will be difficult to transact on an auction property as most auctions will not allow for the sale to be delayed in order to process closing documents, so it is important to clearly understand the rules of the specific auction property you are targeting.
Find the Best Professionals Available
With so many variables and potential pitfalls involved, it is essential that you use a highly experienced QI. You might also want to discuss your goals with a financial advisor, who may be able to improve on your plan or give you other advice to make the transaction more secure.
At CWS Capital Partners, we are a fully-integrated multifamily real estate investment management firm that offers everything from due diligence and risk management to transaction support and property management. We specialize in assisting our clients with 1031 exchanges, acquisitions, repositioning, and development. We own and manage luxury multifamily investment communities in major markets around the country, and we employ a team of experts who can help you hone your investment strategy.
Please contact us to learn more about investing with CWS Capital Partners.
The information provided here is for your general informational purposes only. It should not be considered a recommendation or personalized advisory advice. CWS has made this third party information available from authors it believes are knowledgeable and reliable resources. However, its accuracy or completeness cannot be guaranteed and sentiment may change due to legal or economic conditions.
All investments involve risk including the possible loss of principal. You should familiarize yourself with all risks associated with any investment product before investing.
Advisory services are provided by CWS Capital Partners LLC, a registered investment advisor.
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