Key Takeaways

  • 1031 exchange contract language signals intent to complete a tax-deferred exchange and protects eligibility under IRS rules.
  • Standard cooperation clauses notify the other party and permit assignment of contracts to a qualified intermediary.
  • While not required by law, including 1031 exchange language reduces misunderstandings and ensures smooth closing.
  • Common clauses cover both sale of relinquished property and purchase of replacement property.
  • Timing and proper documentation are critical—language should be in place before closing to avoid disqualification.

1031 Tax-Deferred Exchange Contract Language refers to the contractual language used in real estate when a taxpayer wishes to sell one property and buy another for investment purposes.

When it comes to real estate investments, the Internal Revenue Code requires specific language in both purchase and sale agreements establishing an investor's intent to perform an exchange. This language specifies that an investor intends to sell their investment property and purchase a new one for investment purposes. For such an exchange to occur, the contract must express the intention. This is necessary in order for the exchange to qualify for the IRS. Not only does this verbiage establish the investor's intent, but it enables firms, like Exchange Resource, to associate with the sale and purchase contracts.

The specific contractual language related to this intention allows a company to complete all tasks necessary for finalizing the exchange. Also, the language provides advance notification to the other party that the contract will need to be assigned to an intermediary.

Section 1031 Exchanges

While many taxpayers include phrases within their purchase and sale contracts to establish their intent to exchange, the Internal Revenue Code does not require this in a Section 1031 tax-deferred exchange. The motive behind selling and purchasing property is what makes a Section 1031 exchange different than other real estate transactions. Taxpayers and real estate investment professionals may add a Section 1031 exchange clause to the agreements for several reasons, including:

  • Establishing their intent to complete an IRC Section 1031 tax-deferred exchange.
  • Notifying the other party of the intent to assign the purchase or sale contract to a qualified intermediary.

For a Section 1031 exchange, it is imperative that the purchase and sale contracts for both parties be assignable. To arrange a regular exchange transaction that involves direct deeding, the qualified intermediary needs to be assigned into a contract as the buyer of the new property and seller of the relinquished property. The taxpayer must examine their agreements to make sure they are not prohibited from transferring their buyer/seller positions to a qualified intermediary.

In a normal delayed exchange associated with direct deeding and structured by a qualified intermediary, the closing settlement statement will show the qualified intermediary as the seller instead of the taxpayer. The contractual language shows that there are no issues regarding either the purchase or sale of the property.

Importance of Including 1031 Exchange Language

Although the IRS does not require specific 1031 exchange contract language, most real estate professionals strongly recommend it. Including such language serves three main purposes:

  • Clarity of intent: It makes the taxpayer’s intent to use Section 1031 explicit, which helps avoid disputes.
  • Notification to all parties: Buyers, sellers, agents, and closing officers are informed that assignments to a qualified intermediary will occur.
  • Administrative ease: Having the cooperation clause in place streamlines document preparation, minimizes delays at closing, and ensures the transaction structure complies with IRS guidelines.

Without this language, last-minute issues can arise—particularly if the closing agent is unaware that contract assignments are necessary for a valid exchange.

Section 1031 Exchange Clauses

Some typical language used within Section 1031 tax-deferred exchanges include:

  • Sale of Relinquished Property: “Buyer is aware that seller intends to perform an IRC Section 1031 tax-deferred exchange. Seller requests buyer's cooperation in such an exchange and agrees to hold buyer harmless from any and all claims, costs, liabilities, or delays in time resulting from such an exchange. Buyer agrees to an assignment of this contract to a qualified intermediary by the seller.”
  • Purchase of Replacement Property: “Seller is aware that buyer intends to perform an IRC Section 1031 tax-deferred exchange. Buyer requests seller's cooperation in such an exchange and agrees to hold Seller harmless from any and all claims, costs, liabilities, or delays in time resulting from such an exchange. Seller agrees to an assignment of this purchase and sale agreement to a qualified intermediary by the buyer.”

Common Features of Cooperation Clauses

Most 1031 exchange cooperation clauses, whether on the sale or purchase side, share several key features:

  • Acknowledgment of intent: The clause states that the buyer or seller intends to complete a 1031 exchange.
  • Assignment permission: The other party agrees to the taxpayer assigning the contract to a qualified intermediary.
  • Hold-harmless language: The non-exchanging party agrees to cooperate, provided they do not bear additional costs, liabilities, or risks.
  • No impact on obligations: The clause clarifies that the exchange does not alter the agreed purchase price, timing, or overall responsibilities.

For example, a cooperation clause might include wording such as: “The parties agree to cooperate in effecting an IRC Section 1031 exchange, at no additional cost or liability to the non-exchanging party.”

Adding Section 1031 Language to Sale and Purchase Contracts

The real estate agents who are associated with both the new and relinquished properties are responsible for adding Section 1031 language into the sale and purchase contracts. If the language is not included in the original contracts, the assigned agent may add the language once they become involved in escrow. As another option, all involved parties may sign an IRS form instead of adding the language directly into the contracts.

Shortly before closing, it's still possible to turn an otherwise taxable sale into a Section 1031 exchange. If the taxpayer wishes to set up an exchange right before closing, they must immediately contact a qualified intermediary to prepare the necessary exchange documents. Such preparation will usually include written notice of the assignment of both the purchase and sale agreements and the forwarding of exchange documents to the appropriate entities (typically the closing officer) before the sale closes on the relinquished property.

Timing and Best Practices for Contract Language

Ideally, 1031 exchange contract language should be included at the time the purchase and sale agreements are drafted. This avoids confusion later in the transaction. Best practices include:

  • Insert clauses early: Place the cooperation clause in the initial contract drafts rather than waiting until escrow.
  • Use standardized language: Many title companies, brokers, and intermediaries provide model 1031 clause templates to ensure consistency.
  • Confirm assignability: Contracts should be reviewed to verify that assignment to a qualified intermediary is not prohibited.
  • Coordinate with professionals: Attorneys, agents, and intermediaries should be aligned on the exact language used.

If contract language is omitted, parties can sometimes add it via amendment or acknowledgment forms. However, doing this late in the process may complicate or delay closing.

Frequently Asked Questions

  1. Is 1031 exchange contract language required by law?
    No. The IRS does not mandate specific language, but including it helps prevent disputes and ensures smooth assignment to a qualified intermediary.
  2. What happens if my contract doesn’t include a 1031 clause?
    The exchange may still proceed, but you might need amendments or additional documentation. Missing clauses can cause confusion or delay at closing.
  3. Who drafts the 1031 exchange cooperation clause?
    Usually, real estate agents or attorneys include the language in the purchase and sale contracts. Qualified intermediaries often provide model clauses as well.
  4. Can both the buyer and seller use 1031 exchange language in the same deal?
    Yes. It is possible for both sides to complete exchanges, with each party including appropriate cooperation clauses in their contracts.
  5. Does a cooperation clause change the buyer’s or seller’s obligations?
    No. The clause simply allows assignment of the contract for exchange purposes. It does not alter the purchase price, closing timeline, or contractual duties.

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