Benefits of 1031 Exchanges for Lenders

Increase your mortgage applications, earn additional and larger commissions

  • Educating your existing clients on 1031 exchanges and their many benefits can motivate your customers to sell property that no longer fits their needs and acquire desirable replacement property.
  • Financing is almost always needed on the replacement property and most Exchangers use their exchange funds to leverage into a greater valued property.
  • All equity from the sale of the relinquished property must be reinvested but nothing precludes the Exchanger from refinancing after the replacement property is acquired. This results in two separate mortgage applications and commissions.

Build customer loyalty

  • Knowing a client’s short and long-term objectives and helping him/her accomplish them establishes you as a trusted advisor. A 1031 exchange is often an excellent vehicle to accomplish these goals and your knowledge of 1031 will be invaluable.
  • Suggesting 1031 exchanges when appropriate can help develop a life-time relationship with a valued client.
  • A client that defers a tax bill today is always thrilled to share his/her success story with others. When asked how he/she learned about 1031 exchanges, your client is always more than happy to pass on.

How  Lenders Can Use 1031 Exchanges as a Sales & Marketing Tool 

  • Incorporate the suggestion of 1031 exchanges into your daily work habits
    • If the seller does not live in the property, consider suggesting they look into a 1031 exchange.   
  • Include “Knowledgeable in tax-deferral strategies” in your bio and on social networking bios
  • Educate your clients on 1031 exchanges
    • In your electronic and print newsletters
    • On your website
    • By hosting seminars for your real estate and attorney customers and/or investors
    • In your Blog entries
    • In your social networking entries
  • Stay educated on the basics and new developments with 1031 exchanges
  • Bookmark this page and check back for updates
  • Sign up for Exchanging Times® monthly newsletter
  • Attend 1031 seminars and webinars
  • Keep info handy for your customers

FAQs for Lenders

Is there additional work for the lender when a 1031 exchange is involved?

Most aspects of the acquisition are handled as normal. The only real difference is that proceeds from the sale of the Exchanger’s old property are held by the Qualified Intermediary (QI).

Can an Exchanger obtain a second home mortgage on a 1031 exchange replacement property?

A 1031 exchange is only applicable for properties held for business use or investment. The acquisition of a vacation/second home is very rare in a 1031 exchange and limits the Exchanger’s personal use of the property to just 14 days for each of the first two years of ownership. During the first two years of ownership, the property must also be rented to a non-related party for at least 14 days per year. While some Exchangers are tempted to apply for a second home loan to keep the interest rate down, it could jeopardize the 1031 exchange if the exchange is audited and IRS believes the Exchanger did not have intent to use the property for a qualifying use.

Can lender fees be paid from the 1031 exchange funds?

Unfortunately no lender fees (application fees, points, etc.) can be paid from the exchange funds. Most advisors classify these fees as loan acquisition fees and not routine property closing costs which result in a taxable event. To be safe, the Exchanger should pay these funds out-of-pocket.

Why is it important to make changes to the Settlement Statement?

While the 1031 regulations do not specifically require the changes to the Settlement Statement, the changes go a long way to properly document the exchange transaction in the unlikely event of an audit. Some of the changes a QI will ask the closing agent to make include:

  • List the QI as well as the Exchanger
  • Change the word(s) Buyer/Borrower to Exchanger
  • List “1031 Exchange – Replacement Property” at the top of the settlement statement
  • Provide a signature line for the QI
  • Include a line item to show the 1031 exchange funds held on deposit by the QI
  • Any excess funds are usually returned to the QI and held until the end of the 180-Day Exchange Period
What exchange documents should the mortgage company obtain for their file?

There really are no exchange documents the lender needs to have for his/her file.

Can the lender obtain proof of funds on deposit with the QI?

With written authorization from the Exchanger, the QI can provide the lender with a letter confirming the amount of funds on deposit. Simply notify the QI for the confirmation.

What is the purpose of the 1031 exchange cooperation clause in the Agreement of Sale?

There are three general purposes of this clause. (1) Provide the required notification to the Seller of the replacement property of the Exchanger’s intent to complete a 1031 exchange; (2) Assign the Exchanger’s rights (but not obligations) in the Agreement of Sale to the QI; and (3) Provide the Seller with a hold harmless clause assuring him/her there is no additional cost or liability as a result of the exchange and it will not delay closing.

How is the earnest money deposit on the replacement property handled?

If the relinquished property has not yet been conveyed to a buyer, the Exchanger should pay the deposit and it can be reimbursed when he/she acquires the new property. If the relinquished property has already closed and there are exchange funds being held by the QI, the deposit monies can be paid from the exchange account provided (1) the proper exchange assignment is in the Agreement of Sale and (2) the QI has written authorization to release the funds.

If the Exchanger is selling a residential property, can he/she buy a commercial property instead?

Yes. Any kind of real estate qualifies under Section 1031 as long as it is held for business use or investment.

"You and your team made this transaction seamless for me! Thank you so much for your efficiency."

-- A. Y., Huntingdon Valley, PA

Need help? Contact our team to ask questions and find out how to get started.

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