1031 Exchanges With Real
Estate Option or Contract Interests

                                          By Mary Lou Schwab CPA, CES

A number of real estate investors are entering into 1031 exchanges real estate option or real estate contract interests such as “pre-construction” contracts. There are very hot markets across the nation where investors are entering into contracts to purchase a property that is to be built. Often times the investor pays a deposit and signs a contract to purchase the property with the ability to assign or sell their contract rights to another party. When the construction of the actual property takes a year or more and the propertyvalues keeps rising, the investor can sell or assign their contract for a nice profit. Rather than paying long-term capital gain taxes some investors are entering into a 1031 exchange tra
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In certain states real estate options or contracts can be considered a “real property interest”. Consequently, many legal authorities consider either an option to purchase real estate or a real estate contract interest as a “real property interest” and therefore the sale of such should be eligiblefor 1031 exchanges. Unfortunately we do not have any IRS authority to fall back on and have no idea if the IRS would ever question such an exchange. Be that as it may many investors are participating in these types of exchanges.

A major consideration for this type of exchange is if the investor can prove that the contract was held for investment. For a 1031 exchange of an option or contract interest this is a material fact thathe investor must be able to defend since they are unable to hold the property for business use as no rental income was ever received

Participating in a 1031 exchange for option contracts or real estate contract interests provide other interesting challenges as well. Since there is no closing agent who prepares a settlement statement, often times the investor’s accountant or Qualified Intermediary prepares a settlement statement. The actual transfer date of the real estate interest would need to be determined and all net proceeds from the sale are sent directly to the Qualified Intermediary. Another dilemma is how to value the contract. Is it the actual purchase price that is specified on the contract or is it the valuedetermined from the sale of the actual contract. Most accountants choose the value based on the net profit made from selling the option or real estate contract interest.

An investor cannot receive the funds from the actual sale of the real estate interest or option andthen decide to do a 1031 exchange at a later date. The same 1031 limitations for constructive receipt apply whether an investor is selling real estate or a “real property interest”. The investor should also enter into an exchange agreement with a qualified intermediary. Lastly, the 45 anday exchange deadlines would still apply

Before entering into this type of option contract or real estate contract interest exchange check with your direct legal advisor and accountant. This is not an exchange to charge into without the understanding the risks involved, documentation required and using an experienced intermediary.


©2005 Bankers Escrow Corp. Mary Lou Schwab CPA, CES (Certified Exchange Specialist) is Vice President of Bankers Escrow Corporation and oversees the 1031 Exchange Division. She has over 23 years experience in real estate taxation. For questions on 1031 exchanges call 303-986-4848 or 800-5716595. Bankers Escrow Corporation provides qualified intermediary services for all types of exchanges including simple deferred, reverse, construction, and business property exchanges.