Practical 1031: Is There Anything That Needs to Be in a Real Estate Sale Contract for an Internal Revenue Code Section 1031 Exchange?

Under the Code Section 1031 safe-harbor regulations, the exchanging party must assign its rights under the sale contract to a qualified like-kind exchange intermediary (the “QI”). Obligations under the sale contract are not assumed by the QI, so it is customary for the exchanging party to assign its rights (but not its obligations) to the QI.

Some sale contracts contain express prohibitions on the transfer of contract rights. To make certain that such provisions do not prevent a party from accomplishing an exchange, a sale contract should always permit either party to assign its rights (but not its obligations) to a QI as part of an exchange.

In addition, the 1031 safe-harbor regulations require that the other parties to the exchange be given notice of the assignment of contract rights to the QI. This must occur at or before closing. As a matter of having proof that the notice was given, an exchanging seller will want the purchaser to acknowledge that it has received the seller’s notice of assignment. Thus, it is useful for the sale contract to require that the purchaser give a written acknowledgment of receipt. The same applies if the purchaser is the exchanging party.

While there are many iterations of 1031 exchange sale contract provisions, many far longer than they need to be (leave it to us lawyers), a simple paragraph will usually do. Here is one example:

“Notwithstanding anything to the contrary in this Agreement, each party to this Agreement may assign its rights (but not its obligations) under this Agreement to a qualified intermediary for purposes of accomplishing an Internal Revenue Code 1031 like-kind exchange in connection with its sale or purchase of the Property. Each party to this Agreement agrees to provide a written acknowledgment of its receipt of notice of such assignment when presented with such notice by the other party.”

An exchange provision such as this ought to be part of every sale contract. A seller need not decide whether to actually do an exchange until closer to closing when an exchange account is set up with a QI (more about that in a future 1031 Q&A). If a party does not elect to do an exchange, the provision just mentioned remains unused and does not burden either party.

For more information:

Practical 1031: What is an Internal Revenue Code Section 1031 Like-Kind Exchange?