1. DO NOT include the note in the exchange and pay any taxes that may be due. The taxpayer would
receive the note as the beneficiary at the closing and pay taxes on this portion of the capital gain
under the installment sale method which is specified in IRC Section 453.
2. Include the note in the exchange by initially showing the “qualified intermediary” as the beneficiary on the installment note and possibly defer the capital gain taxes.
In option 1, the taxpayer is electing to take the installment note method pursuant to §453. The note is made payable to the taxpayer and is received by the taxpayer at the closing of the relinquished property sale.
In option 2, the taxpayer has four different alternatives for attempting to use the note as part of the consideration for purchasing replacement property in a 1031 exchange. In order to avoid “constructive or actual receipt” by the taxpayer, the qualified intermediary is named as the beneficiary on the
USE THE NOTE TOWARDS THE DOWN PAYMENT ON THE REPLACEMENT PROPERTY
The seller of the replacement property accepts the installment note as partial consideration towards the purchase price of the replacement property. In this scenario, the note is assigned to the seller of the replacement property by the qualified intermediary and delivered to the seller at the replacement
TAXPAYER PURCHASES INSTALLMENT NOTE FROM THE QUALIFIED INTERMEDIARY
The taxpayer purchases the installment note from the qualified intermediary. The sale of the installment
note to the taxpayer takes place during the exchange period, thus allowing the qualified intermediary to apply the note proceeds towards the replacement property purchase.