Earnest Money Deposit in a 1031 Exchange
We see quite often some realtors do get confused when handling the above working for their investors transacting in a 1031 exchange. In over twenty years’ of experience as a Qualified Intermediary (QI), I like to help address this issue so realtors can plan ahead preventing any confusion between investor vs QI vs the agent in this process.
Generally, there are three phases to complete a 1031 exchange when your investor sells his investment property. These are:
Phase 1 –The sale of the relinquished property to start his exchange
Phase 2 – During the exchange process – can be up to 180 days to close
Phase 3 – The acquisition/closing phase acquiring his replacement property(ies)
The confusion here between agent and investor is during phase 2 listed above. Here are some scenarios all requiring different action to handling earnest money deposit:
- Is your investor buying equal or greater value to his relinquished property sale? If yes, your investor should use funds out-of-his pocket to make earnest money deposit on his new replacement property. In this example, the QI only wire his exchange funds at closing to complete phase 3. Keeping it simple and easy.
- Alternatively, your investor can use his exchange proceeds to make earnest money deposit too. As his agent, it is your role to email the fully executed purchase contract to the QI providing full escrow information as soon as possible. In turn, the QI will contact your investor to complete a wire request form before funds can be transfer. Without a signed wire authorization form, QIs are not allowed to wire funds due to liability. This request can take a day or two to execute if QI is unable to locate your investor, please be mindful.
- What if your investor is out of town and cannot access a computer to authorize a wire? No problem, have your investor made the earnest money deposit via his bank to the Title company to open escrow first. At closing, he can instruct the Title company to reimburse him for his original deposit after exchange funds have been wired from the QI.
- What if your investor is buying lower value in his 1031 exchange? If so, I recommend he use funds from his exchange account to do so. There is no point in using personal funds to make earnest money deposit since he is going to pay taxes at the end of his exchange called “Cash Boot”. This helps lower his tax liability. If he is out of town, do so using his personal funds and reimburse from the title company at closing to save time.
As you can see, depending on the investor’s exchange need (buy equal, higher or lower value), requires different approach on how to handle earnest money deposit. Be proactive and communicate to the QI before drawing up purchase offer(s) on behalf of your investor, eliminating any confusion, delays. or anger! If you the agent is on top of the money trail, it will impress your client ensuring repeat business!
Wai-Yew Lam, President
TREC Certified Instructor