What Can An Exchanger Do
– The “1031 Fall-Back”!
In the event the Exchanger, having begun an exchange, cannot locate desirable property or is unable to purchase sufficient replacement property to fully defer their gain, the Exchanger would normally receive all of the remaining exchange funds at the end of the exchange period, which will trigger a gain recognition event. Instead, using the “1031 Fall-Back” option, the Exchanger, through the Qualified Intermediary prior to the expiration of the exchange period, can choose to receive return of their exchange funds in payments over a period of years.
What is a “1031 Fall-Back” and how does it work? The “1031 Fall-Back” is a variation of a “Structured Sale”. A “Structured Sale” is a special type of installment sale authorized under the Internal Revenue Code. Installment sales permit sellers to defer recognition of gains on the sale of a business or real estate to the tax year in which the related sale proceeds are received. “Structured Sales” allow the seller of an asset to pay taxes over time while having the payments guaranteed by a credit worthy alternate obligor (i.e. an annuity issued by an insurance company), who accepts assignment of the buyer’s periodic payment obligation.
In a “Structured Sale” or a “1031 Fall-Back”, rather than the buyer or Qualified Intermediary paying the installments, the buyer’s cash or Exchanger’s unused exchange funds is used as consideration for a third party assignment company to accept the payment obligation. The assignment company then purchases an annuity from a life insurance company. Case law and administrative precedents support recognition of the original contract terms after a substitution of obligors. In addition, a properly handled “1031 Fall-Back” transaction will avoid any issues with constructive receipt.
While negotiating the installment payments for the “1031 Fall-Back”, the Exchanger is free to design payment streams with a great deal of flexibility. Each installment payment to the Exchanger has three components: deferred return of basis, deferred capital gain or recapture, and ordinary income earned on the money in the annuity. With a properly documented “1031 Fall-Back”, no taxable event is recognized unless a payment is actually received. Taxation is the same as if the Exchanger were receiving installment payments from the original buyer.
The “1031 Fall-Back” must be properly documented by the Qualified Intermediary, and the exchange funds must be handled in such a way that the Exchanger is not treated as having constructively received the payment prior to the time it is actually paid.
Transactions can currently be done on exchange funds of $150,000 or more. There are no direct fees to the Exchanger to employ the “1031 Fall-Back” strategy. The structured settlement sales specialist who implements the transaction is paid directly by the life insurance company that writes the annuity. IPX1031 may receive a financial benefit from the issuer of the annuity product selected by the Exchanger. The internal rate of return is comparable to long term high quality annuity products.
Circular 230 Notice: This communication, including any attachments, is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding tax-related penalties or (ii) promoting, marketing or recommending to another person any tax-related matters addressed herein.
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