Seller Carry-Back Notes

An exchanger may be asked to help a buyer finance the purchase of the relinquished property (the property being sold). In such a circumstance, the exchanger is given a “Seller Carry-Back Note” secured by a deed of trust or mortgage against the Relinquished Property.  However, if the Note is in the name of the exchanger, it will be considered “Boot” and taxable. Therefore, when a Taxpayer elects to carry-back a note on the Relinquished Property, there are two essential options:

1.   Make the Note payable to the Taxpayer.  The Taxpayer receives “Installment Sale Treatment” (as specified in IRC §453) and pays taxes on this portion of the capital gain as they receive it. 

2.   Make the Note payable to the Qualified Intermediary in order to avoid “constructive or actual receipt” by the Taxpayer. This allows four different alternatives for attempting to use the Note as part of the Tax-Deferred Exchange: 

·   Use the Note towards the Down Payment on the Purchase of the Replacement Property.  The Seller of the Replacement Property accepts the Note as partial payment towards the purchase price.  In this scenario, the Note is assigned to the Seller by the Qualified Intermediary and delivered to the seller at the closing.

·   Taxpayer Purchases Note from Qualified Intermediary.  Essentially, the Taxpayer purchases the Note from the Qualified Intermediary.  This allows the Qualified Intermediary to apply the cash to the Replacement Property.

·The Note is Paid Off prior to closing on the Replacement Property.  The Note is paid in full during the exchange period.  This works only on short-term notes due within the 180 day exchange period.  The proceeds are then applied to the acquisition of the Replacement Property.

·Sell the Note to a Third-Party.  The Taxpayer finds an investor to purchase the Note, thereby replacing the Note with cash.  If the Note is “Discounted”, the discounted portion is considered “Boot” and may be taxable.

When there is a Seller Carry-Back Note, there would be 3¨÷% withholding in the state of California at the time escrow closes unless the buyer agrees to withhold 3¨÷% of each payment and submit to the Franchise Tax Board each month.