This article presents an exchange agreement form used to initiate a §1031 transaction where the ownership of properties is exchanged between two persons.
Structuring a comprehensible transaction
An exchange of properties is an arrangement structured as an agreement and entered into by owners of two or more parcels of real estate who agree to transfer the ownership of their properties between themselves in consideration for the value of the equity in the properties received. Economic adjustments are made for any difference in the valuations given to the equities in the properties exchanged.
Thus, the owners of real estate, on entering into a written exchange agreement, agree to sell and convey their property to the other party. However, unlike a sale under a purchase agreement, the down payment is not in the form of cash. Instead, the down payment is the equity in property each owner will receive. The dollar amount of the down payment is the value given to the equity in the property to be received in exchange.
In an exchange of equities, as in the sale of property with a cash down payment, the balance of the price agreed to must be paid in some form of consideration. If a sales price is to be paid in cash, the balance of the price after the down payment is typically funded by a purchase-assist loan.
Conversely, in a sale calling for a cash down payment and an assumption of the loan of record, any balance remaining to be paid on the price is usually deferred, evidenced by a carryback note. The carryback note in a cash down payment sale presents no different a situation than the carryback note in an “equity down payment” situation, such as occurs in an exchange of an equity in one property as a down payment toward the purchase of a larger equity in another property, called an adjustment or balancing of equities.
Also, unlike a cash sale which “frees up” the capital investment in real estate by converting the equity to cash proceeds on closing, an exchange is a clear manifestation of the owner’s desire to continue his investment in real estate. In an exchange, the owner disposes of a property he no longer wants.
The owner might use his equity in an estate building plan to move up into property of greater value (and greater debt leverage), or simply to consolidate several properties the owner has that he exchanges to acquire a single, more efficiently operated property.
The hallmarks of an exchange transaction, in contrast to the common features of a sales transaction, include:
· the exchange of equities in real estate in lieu of a cash down payment;
· no good-faith deposit as cash is rarely used in an exchange of equities, except for prorations, adjustments (such as security deposits), transactional expenditures or as a “sweetener” to encourage an acceptance of the exchange offer, since the signature of each party commits them to perform on the exchange agreement and is the only consideration needed from each party to form a binding contract;
· a take-over of existing financing by an assumption of the loans or a transfer of title subject to the loans, rather than refinancing and incurring expenses that greatly increase the cost of reinvesting in real estate;
· adjustments brought about by the difference in the value of the equities exchanged, a balancing that requires the owner with the lesser valued equity to cover the difference in cash installments evidenced by the execution of a promissory note or the contribution of additional personal property or real estate of value;
· joint or tandem escrows, interrelated due to the conveyance of one property as consideration for the conveyance of the other property, similar in effect to a cash sale of a property when the closing is contingent on the sale of other property to obtain the funds needed to close escrow, a contingency that does occur in some delayed §1031 reinvestment plans;
· two sets of brokerage fees, one for each property involved in the exchange, rather than the receipt of a single fee as occurs in a cash-out sale of property;
· one party simultaneously selling and buying, a coupling of two properties consisting of a sale of one and purchase of the other, motivated primarily by the tax compulsion to remain invested in business or investment real estate, called like-kind properties, rather than cash out on the sale of one and later separately locate, analyze and purchase a replacement property with the cash proceeds of the sale, as occurs in a delayed “sell now/buy later” §1031 reinvestment plan; and
· tax advice from a real estate broker counseling on the profit tax avoidance of a coordinated, simultaneous reinvestment of the owner’s equity in business or investment category real estate in a replacement property, thus avoiding the need to first locate a cash buyer to convert the equity to cash and then scramble to locate property and reinvest the sales proceeds within specific time periods while avoiding receipt of the proceeds.
Commonality with a sale
The common features found in the acquisition of real estate by either a cash purchase or an exchange of equities include:
· a disclosure by the owner and listing broker of the conditions known to them about the property improvements, title, operation and natural hazards of the location which adversely affect the property’s market value or the buyer’s intended use of the property; and
· a due diligence investigation by the buyer acquiring title concerning his ownership, use and operation of the property.
As in all real estate transactions, a form is used to prepare the offer and commence written negotiations. The objective of a written agreement is to provide a comprehensive checklist of boilerplate provisions for the parties to consider in their offer, acceptance and counteroffer negotiations.
Also, the terms of an exchange agreement must be sufficiently complete and clear in their wording to prevent a misunderstanding or uncertainty over what the parties have agreed to do should the agreement require enforcement by one or the other party.
Once the brokerage process of locating a suitable replacement property has produced a property the owner is willing to acquire in exchange for the property he wants to dispose of, the broker prepares an exchange agreement on a preprinted or computer generated form. When prepared, the terms are reviewed with the owner, signed by the broker and the owner, and submitted to the owner of the replacement property for acceptance. [See Form 171 accompanying this article]
An exchange agreement form will only be used when an owner’s equity in a property is offered as a down payment in exchange for replacement property. An owner who has already entered into a purchase agreement to sell his property to a cash buyer will make a separate offer to purchase a replacement property by using a purchase agreement form to reinvest the proceeds from his sale.
Locating properties for exchange
Taxwise, a client making an offer to exchange like-kind real estate usually plans to complete a fully qualified §1031 reinvestment. Thus, he will acquire real estate with greater debt and greater equity than exists in the property he now owns, a trade-up arrangement for estate building, not a piecemeal liquidation of his asset for a partial §1031 exemption.
When the exchange is a fully qualified §1031 reinvestment, all the profit in the property sold or exchanged is tax exempt.
Thus, the profit on the sale of the property is literally transferred, untaxed, to the replacement property. As a result, the entire cost basis in the property exchanged is always carried forward to the replacement property acquired in the exchange.
In the quest to locate suitable replacement properties for a client, the listing broker marketing the client’s property needs to locate properties which are owned by a person who will consider acquiring the client’s property. In essence, the broker attempts to arrange a transaction which will match two owners and their properties, a somewhat daunting task requiring a constant search for properties whose owners are willing to take other property in exchange.
To locate such an exchange-minded owner who is willing to consider owning the client’s property, the listing broker is nearly always limited to those owners known to the broker to have acceptable replacement property or have listed their properties with other brokers. Hopefully, the other brokers have counseled their clients on an exchange of properties.
The most productive environment for locating owners of qualifying properties who have an interest in acquiring the client’s property seems to exist at marketing sessions attended by many brokers and agents. At these meetings, they “pitch” their listings and advise attendees about the types of property their clients will accept in an exchange.
Multiple listing service (MLS) printouts, websites and large brokerage firms with income property sales sections also help in the process of locating qualifying properties. However, the agent considering an exchange usually needs to make a personal contact with the agent who represents the owner of suitable property to determine the likelihood of that owner entering into an exchange.
To get an initial response from other brokers and agents regarding the inclination of their owners to exchange, a preliminary inquiry about a possible match up of properties and owners can be made in the form of a written proposal. The proposal should precede any analysis or investigation into the property listed by the other broker, and include only its type, size and location to qualify it as a potential match for the client.
Prudently, an offer to exchange would not be prepared and submitted before getting a reading on the other owner’s willingness to consider an exchange of properties, and more particularly, an exchange for a property of the type owned by the client.
To inquire of another broker or agent into the possibility of an exchange and at the same time document the inquiry for further reference, a preliminary proposal form is often prepared and personally handed or faxed to the other broker or agent. The proposal will note the type of properties involved, their equities and debt, and arrange for the exchange of information or a discussion between the agents before preparing an exchange agreement. [See first tuesday Form 170]
The preliminary proposal is not an offer and does not contain contract wording. The clients are not involved in the proposal, only the brokers. Their effort is to locate properties to be submitted to their clients for exchange consideration. Only after the probability of actually entering into an exchange is established will an exchange agreement offer be prepared, signed by the client and submitted for acceptance.
Equity valuation adjustments
Once replacement property is located and its owner has indicated a willingness to consider an exchange of properties, the dollar amount of the market value of each property must be established. Once the market value of each property is established, the value of the equity can be set. Valuation is the single most important task in negotiating an agreement to exchange.
Until a consensus exists between the owners about the value of the equity in each owner’s property, negotiations tend not to go forward. Without an agreement on valuation, it follows that the amount of the adjustment for any difference between the equities in each property to the exchange cannot be set. Property disclosures and due diligence investigations tend to fall in place only when the values of the equities have been agreed to.
The broker begins negotiations to set the dollar amount of equity each owner has in his property by preparing an exchange agreement offer. The offer is based on the owner’s and the broker’s analysis of valuations, including:
· the market value (price) of each property to be exchanged [See Form 171 §1.3 and 2.3];
· the loan amounts encumbering each owner’s property, whether or not they are to remain of record; and
· the equity valuations calculated as the market value of each property less the amount of loans of record.
Having stated the present value of the equity in each property (as viewed by the owner), adjustments need to be entered in the offer to cover the difference between the equity valuations in each property.
Since the equities in properties exchanged rarely are of the same dollar amount, adjustments will nearly always have to be negotiated. Thus, a contribution of money (cash or carryback promissory notes) or other property, collectively called cash boot, must be given by the owner of the property with the lesser amount of equity value, a consideration paid in a process called adjusting or balancing the equities.
Thus, the owner of the property with the larger amount of equity will receive one or more cash items as consideration for the adjustment, including:
· cash;
· carryback note; or
· other property, either real or personal, with a dollar amount of value.
Regarding the existence of financing which encumbers the properties being exchanged, negotiations may call for the loans to remain of record or be paid off and reconveyed.
Refinancing of the replacement property may be necessary to generate cash funds for the payoff and reconveyance of the loans now encumbering the property. A contingency provision for new financing is needed if additional cash for the payoff of loans is required.
Cultivating an exchange environment
Consider an agent who has a working knowledge of income property transactions in the region surrounding his office. The agent regularly attends marketing sessions and visits with brokers and agents whose clients have properties they would like to convert to cash or exchange for other properties.
An investor who is an acquaintance of the agent is known to the agent to be unhappy with the management aspect of a smaller residential rental property he owns. The investor would prefer to own a single-user property requiring little of his time to oversee maintenance and repairs.
Discussions the agent has with the investor about selling the units and locating a more suitable property to meet the investor’s ownership objectives culminates in a listing of the property with the agent (on behalf of his broker).
A reinvestment provision is included in the listing calling for the location and acquisition of replacement property to provide the continuing investment in real estate required to qualify the sale for the Internal Revenue Code (IRC) §1031 exemption from any profit tax. The investor has owned the property for quite some time and his basis is low compared to the property’s present market value.
Soon the agent locates an industrial property which is owned by a businessman whose company occupies the entire building. The property is listed with another broker who explains his client would be willing to lease back the property from the buyer rather than move to other premises. The businessman’s broker knows his client’s objective is to reduce his debt so he can enlarge the credit line for his business.
On inquiry as to whether the businessman would take residential income units (with a much smaller loan) in exchange for his property, the agent gets a positive response. It happens the businessman owns other residential properties and their management does not pose a problem for him.
Information on the properties is exchanged. The investor’s units are priced at $600,000 with a debt of $200,000 and an equity valued at $400,000. The industrial building belonging to the businessman is listed at $1,200,000 subject to a loan of $700,000 with an equity of $500,000.
When data on the industrial property is reviewed with the investor as a probable replacement property under a net lease with the owner/occupant, the investor indicates it is just the situation he is looking for. He will be acquiring a property with a higher value to add to his investment portfolio and the demands on management will be minimal.
The flow of rental income will cover payments on the loan and generate spendable income. The agent then conducts preliminary investigations into the property and the loan encumbering it.
The agent prepares an exchange offer. Besides the routine due diligence investigation into each property and typical contingencies and closing provisions, the agent needs to negotiate the adjustment for the $100,000 difference between the equities in the two properties and the terms of a lease for the businessman’s continued occupancy of the industrial building.
Thus, the consideration the investor will offer to pay the price of $1,200,000 for the industrial property includes:
· the $400,000 equity in his residential units;
· an assumption of the $700,000 loan on the industrial building;
and
· execution of a $100,000 note in favor of the businessman, the adjustment necessary to balance the equities between the two properties exchanged.
Thus, the total consideration offered by the investor to buy the industrial building is $1,200,000.
Conversely, the consideration the investor wants from the businessman in exchange for the investor’s residential units and the investor’s execution of a carryback note in favor of the businessman includes:
· the $500,000 equity in the industrial property;
· an assumption of the $200,000 loan on the residential units; and
· a $100,000 offset by the investor’s execution of a carryback note to be secured by the industrial property.
Thus, the total consideration the businessman will pay for the residential units on acceptance of this offer is $600,000.
The leaseback arrangements offered by the investor are based on the market value of the industrial property and rents paid for comparable properties. The terms of the lease are set out in an addendum attached to the exchange agreement offer.
The offer is submitted to the broker representing the businessman. In turn, a counteroffer is submitted to the investor based on all the terms of the exchange agreement, modified as follows:
· the carryback note provision is deleted; and
· the amount of $100,000 in cash is to be paid to adjust the equities.
Ultimately, escrow is opened based on an adjustment in the amount of $90,000; comprised of a $50,000 note and $40,000 in cash and a price reduction for the $10,000 difference.
Analyzing the exchange agreement
The exchange agreement, first tuesday Form 171, is used to prepare and submit a property owner’s offer to acquire other real estate in exchange for property he owns, neither property being a one-to-four unit residential property.
The exchange agreement offer, if accepted, becomes the binding written contract between each owner. Its terms must be complete and clear to prevent misunderstandings so the agreement can be judicially enforced.
Each section in Form 171 has a separate purpose and used for enforcement. The sections include:
1. Identification: The date of preparation for referencing the agreement, the names of the owners, the description of the properties to be exchanged and each property’s fair market value, equity valuation and loan encumbrances are set forth in sections 1 and 2 to establish the facts on which the agreement is negotiated.
2. Terms of exchange: The total consideration each owner is to deliver to the other owner, such as the transfer of their equity and adjustments in the form of cash, carryback note, loan assumptions or value in additional property, and any new financing required to generate the cash needed to acquire the replacement property are set forth in section 3.
3. Acceptance and performance: Aspects of the formation of a contract, excuses for nonperformance and termination of the agreement are provided for in section 4, such as the time period for acceptance of the offer, the broker’s control over enforcement of performance dates, the financing of the price as a closing contingency, procedures for cancellation of the agreement, cooperation to effect a §1031 transaction and limitations on monetary liability for breach of contract.
4. Property conditions: Each owner’s confirmation of the physical condition of the property received as disclosed prior to acceptance is confirmed as set forth in sections 5 and 6 by each owner’s delivery of information on their property for the other party’s due diligence review and approval, such as rental income, expenses and tenant estoppels, natural and environmental hazards, physical conditions of improvements, title condition, security from crime, as well as providing certification of their property’s condition on transfer, such as structural pest control, compliance with local occupancy ordinances and safety standards.
5. Closing conditions: The escrow holder, escrow instruction arrangements and the date of closing are established in section 7, as are title conditions, title insurance, hazard insurance, prorates and loan adjustments.
6. Brokerage and agency: The release of sales data on the transaction to trade associations is authorized, the brokerage fee is set and the delivery of the agency law disclosure to both parties is provided for as set forth in section 7, as well as the confirmation of the agency undertaken by the brokers and their agents on behalf of one or both parties to the agreement.
7. Signatures: Both parties bind each other to perform as agreed in the exchange agreement by signing and dating their signatures to establish the date of offer and acceptance.
Preparing the exchange agreement
The following instructions are for the preparation and use of the Exchange Agreement, first tuesday Form 171. Form 171 is designed as a checklist of practical provisions so a broker or his agent can prepare an offer for an owner to exchange properties located in California that do not include one-to-four unit residential property.
Each instruction corresponds to the provision in the form bearing the same number.
Editor’s note — Check and enter items throughout the agreement in each provision with boxes and blanks, unless the provision is not intended to be included as part of the final agreement, in which case it is left unchecked or blank.
To alter the wording of a provision or to delete or add a provision, use addendum first tuesday Form 250. On it, reference the section number in the exchange agreement to be altered or deleted. If altered, enter the copy that is to supersede the boilerplate provision referenced.
Document identification:
Enter the date and name of the city where the offer is prepared. This date is used when referring to this exchange agreement.
Properties to be exchanged:
1.1 First party and his property: Enter as the first party the name of the owner who is initiating this offer to exchange properties.
Enter the city, county and state in which the first property is located. Enter the legal description or common address of the property, or the assessor’s parcel number (APN). If more than one like-kind property is being exchanged by the first party, include the description, financing and equity of the additional property in an addendum. [See first tuesday Form 250]
1.1 Equity valuations: Enter the dollar amount of the equity in the first property, calculated as the property’s fair market value minus the principal balance on the loans of record.
1.2 Existing loans: Enter the total amount of the
principal debt outstanding on the loans encumbering the first property.
a. First trust deed: Enter the amount of the unpaid principal, monthly principal and interest (PI) payment and the interest rate on the first trust deed loan encumbering the first property. Check the box to indicate whether the interest is adjustable (ARM). Enter the due date for any final balloon payment due on the loan. Enter any unique loan conditions such as impounds, alienation restraints, prepayment penalties, guarantees, etc.
b. Second trust deed: Enter the amount of the unpaid principal, monthly PI payments and the interest rate on the second trust deed loan encumbering the first property. Check the box to indicate whether the interest is adjustable (ARM). Enter the due date for any final balloon payment due on the loan. Enter any unique loan conditions such as impounds, alienation restraints, prepay penalties, guarantees, all-inclusive trust deed (AITD) provisions, etc.
1.3 Market value: Enter the total dollar amount of the first property’s fair market value, i.e., the “price” the first party is to receive in exchange for his property.
Editor’s note — The market value set for the first property determines the amount of title insurance, sales and transfer taxes and reassessment for property taxes, as well as fixes the price the first party is paying (and taxable profit) for any non-§1031 property he may be receiving in exchange for his property.
1.4 Personal property included: Enter the description of any personal property or inventory the first party is to transfer as part of the total property value. If an itemized list is available, attach it as an addendum to the exchange agreement and enter the words “see attached inventory.”
2. Second party and his property: Enter as the second party the name of the owner of the replacement property sought to be acquired in the exchange.
Enter the city, county and state in which the replacement property is located. Enter the legal description or common address of the replacement property, or the APN. If the first party is to acquire more than one like-kind property as a replacement in this exchange, include the description, financing and equity of the additional property in an addendum. [See first tuesday Form 250]
2.1 Equity valuation: Enter the dollar amount of the equity in the replacement property, calculated as the property’s fair market value minus the principal balance on the loans of record.
2.2 Existing loans: Enter the total amount of the principal debt outstanding on the loans encumbering the replacement property.
a. First trust deed: Enter the amount of the unpaid principal, monthly PI payments and the interest rate on the first trust deed loan encumbering the replacement property. Check the box to indicate whether the interest is adjustable (ARM). Enter the due date for any final balloon payment due on the loan. Enter any unique loan provisions such as impounds, alienation restraints, prepay penalties, guarantees, etc.
b. Second trust deed: Enter the amount of the unpaid principal, monthly PI payments and the interest rate on the second trust deed loan encumbering the replacement property. Check the box to indicate whether the interest is adjustable (ARM). Enter the due date for any final balloon payment due on the loan. Enter any unique loan provisions such as impounds, alienation restraints, prepay penalties, guarantees, AITD provisions, etc.
2.3 Market value: Enter the total dollar amount of the replacement property’s fair market value, i.e., the “price” the first party is to pay in exchange for the replacement property.
Editor’s note — The market value set for the replacement property determines the amount of title insurance, sales and transfer taxes and reassessment for property taxes, as well as fixes the price the second party is paying (and taxable profit) for any non-§1031 property the first party may be contributing in exchange for the replacement property.
2.4 Personal property included: Enter the description of any personal property or inventory the first party is to receive as part of the total replacement property value. If an itemized list is available, attach it to the exchange agreement and enter the words “see attached inventory.”
3. Terms of the exchange:
3.1 Acquisition of the replacement property: Details the total consideration the first party will deliver to the second party to acquire the replacement property.
Editor’s note — The consideration given by the first party for the replacement property includes the equity value in the first property and adjustments in the form of cash, carryback note or additional property to reflect the difference between the lesser equity value in the first property than the equity value in the replacement property. Also, financial provisions for the first party’s take-over or refinancing of the loans of record on the replacement property are included.
a. Equity value in first property: Enter the dollar amount of the equity value set at section 1.1.
b. Cash adjustment: Enter the dollar amount of any cash payment to be made by the first party to adjust for any difference due to a lesser amount of equity value in the first property than the equity value in the replacement property.
Editor’s note — Only one of the parties will add cash, if at all, to adjust for the differences in equity amounts. Cash for loan payoffs is handled separately at sections 3.1c and 3.2c.
c. Additional cash payment: Enter the amount of the principal balance remaining due on the loans of record encumbering the replacement property as set at section 2.2 if the first party will not be taking over the loans of record on the replacement property (section 3.1d) and the second party is to pay off and reconvey these loans. Funding for this payoff will be provided by the first party refinancing or further encumbering the replacement property.
d. Loan take-over: Check the appropriate box to indicate whether the first party will take title to the replacement property subject to the loans of record or will assume the loans if the loans are to remain of record on the replacement property. Enter the amount of the principal balance remaining on the loans of record on the replacement property as set forth at section 2.2.
Editor’s note — This boilerplate provision for loan takeover does not include the alternative of a novation agreement between both parties and the lender that would terminate the second party’s liability on the loan and, unlike an assumption, would shift all loan liability to the first party.
e. Promissory note adjustment: Enter the dollar amount of any carryback note and trust deed the first party will execute in favor of the second party to adjust for differences in equity valuations due to a lesser equity value in the first property than in the replacement property. Enter as the terms for payment of the carryback note the amount of the monthly payment, the interest rate and the number of years after close of escrow to set the due date for a final balloon payment.
f. Additional property as adjustment: Enter the dollar amount of the equity in any additional property the first party is to contribute to this exchange to adjust for the difference in the larger equity he will receive in the replacement property. The equity in the additional property is calculated as the difference between its fair market value and any debt encumbering it. Enter the description of the additional property. Enter the amount of any debt.
g. Offset for adjustments received: Enter the dollar amount of any cash boot (money, carryback note or other property) the first party is to receive as compensation for the difference between the greater value of the equity in the first property and the lesser equity value in the replacement property. This amount is the sum of any amounts entered in section 3.2b, e and f. The first party’s receipt of an adjustment is subtracted to determine the total consideration the first party will pay to acquire the replacement property.
h. Total consideration: Enter the total dollar amount of all consideration to be paid by the first party to acquire the replacement property as the sum of the amounts entered in this section 3.1 at subsections a, b, c, d, e and f, less the amount entered at subsection g.
i. New financing for replacement property: Check the appropriate box to indicate whether any new financing to be originated by the first party on the replacement property will be a first or second trust deed loan. Enter the amount of the loan, the monthly payment and the interest rate limitations on the loan. Check the box to indicate whether the interest rate will be adjustable. If so, enter the index name controlling the ARM. Enter the number of years the loan is to run until it will be due on a final balloon payment.
3.2 Disposition of the first property: This section details the total consideration the first party will receive from the second party in exchange for the first property.
Editor’s note — The consideration to be received by the first party on the transfer of his property includes the equity value in the replacement property and adjustments made by the second party in the form of cash, carryback note or additional property to reflect the difference between the lesser equity value in the replacement property than the equity value in the first property. Also, financial provisions for the second party’s take- over or refinancing of the loans of record on the first property are included.
a. Equity value in the replacement property: Enter the dollar amount of the equity value set at section 2.1.
b. Cash adjustment: Enter the dollar amount of any cash payment to be made by the second party to adjust for any difference due to a lesser amount of equity value in the replacement property than the equity value in the first property.
c. Additional cash payment: Enter the amount of the principal balances remaining due on the loans of record encumbering the first property as set at section 1.2 if the second party will not be taking over the loans of record on the first property (section 3.2d) and the first party is to pay off and reconvey these loans. Funding for this payoff will be provided by the second party refinancing or further encumbering the first property.
d. Loan takeover: Check the appropriate box to indicate whether the second party will take title to the first property subject to the loans of record or will assume the loans if the loans are to remain of record on the first property. Enter the amount of the principal balance remaining on the loans of record on the first property as set forth at section 1.2.
Editor’s note — This boilerplate provision for loan take-over does not include the alternative of a novation agreement between both parties and the lender that would terminate the first party’s liability on the loan and, unlike an assumption, would shift all loan liability to the second party.
e. Promissory note adjustment: Enter the dollar amount of any carryback note and trust deed the second party will execute in favor of the first party to adjust for the difference in
equity valuations due to a lesser equity value in the replacement property than in the first property. Enter as the terms for payment of the carryback note the amount of the monthly payment, the interest rate and the number of years after close of escrow to set the due date for a final balloon payment.
f. Additional property as adjustment: Enter the dollar amount of the equity in any additional property the second party is to contribute to this exchange to adjust for the difference in the larger equity he will receive in the first property. The equity in the additional property is calculated as the difference between its fair market value and any debt encumbering it. Enter the description of the additional property. Enter the amount of any debt.
g. Offset for adjustment received: Enter the dollar
amount of any cash boot (money, carryback note or other property) the second party is to receive as compensation for the difference between the greater value of the equity in the second property and the lesser equity value in the first property. This amount is the sum of any amounts entered in section 3.1b, e and f. The second party’s receipt of adjustment is subtracted to determine the total consideration the second party will pay to acquire the first property.
h. Total consideration: Enter the total dollar amount of all consideration to be paid by the second party to acquire the first property as the sum of the amounts entered in this section 3.2 at subsections a, b, c, d, e and f, less the amount entered at subsection g.
i. New financing for first property: Check the appropriate box to indicate whether any new financing to be originated by the second party on the first property will be a first or second trust deed loan. Enter the amount of the loan, the monthly payment and the interest rate limitations on the loan. Check the box to indicate whether the interest rate will be adjustable. If so, enter the index name controlling the ARM. Enter the number of years the loan will run until it will be due on a final balloon payment.
3.3 Carryback note conditions: Provides for any carryback note and trust deed, executed to adjust for the equity differences between the properties, to include or be subject to the term and conditions of this section, in addition to the terms for payment of the note established by either section 3.1e or 3.2e.
a. Financial disclosure statement: Check the box to indicate a carryback disclosure statement is to be prepared and handed to the party executing the note, as is mandated in one-to- four unit residential transactions. If so, attach a completed carryback disclosure statement to the exchange agreement for signatures. [See first tuesday Form 300]
b. Special provisions: Check the appropriate box to indicate any special provisions to be included in the carryback note or trust deed. Enter the name of any other unlisted special provisions, such as impounds, discount options, extension clauses, guarantee arrangements or right of first refusal on a sale or hypothecation of the note.
c. Notice of delinquency: Check the box to indicate the party executing the note is also to execute a request for notice of delinquency and pay the cost of recording and serving it on senior lenders. [See first tuesday Form 412]
d. Creditworthiness analysis: Check the box to indicate the party executing the note is to provide the other party with a completed credit application. [See first tuesday Form 302]
e. Approval of creditworthiness: Enter the number of days in which the party carrying back the note may cancel the transaction based on his reasonable disapproval of the other party’s creditworthiness. [See first tuesday Form 183]
f. Subordination of trust deed: Authorizes the party carrying back the note and trust deed to terminate the transaction should the terms arranged for the origination or assumption of loans, secured by trust deeds with priority on title and senior to the trust deed securing the carryback note, fall outside the parameters for amount, payments, interest rate and due dates agreed to in this agreement.
g. UCC-1 for additional security: Requires a security agreement and UCC-1 financing statements to be completed and the UCC-1 to be filed with the Secretary of State to perfect a security interest in any personal property being transferred by the party carrying back the note and trust deed.
4. Acceptance and performance periods:
4.1 Authorized acceptance: Enter the number of days in which the second party may accept this exchange offer and form a binding contract.
4.2 Extension of performance dates: Authorizes the brokers to extend performance dates up to one month to meet the objectives of this exchange agreement, time being a reasonable period of duration and not of the essence in the initially scheduled performance of this agreement.
4.3 Loan contingency: Authorizes the party taking title to a property to cancel the transaction at the time scheduled for closing if the new financing or loan assumption arrangements agreed to fail to occur.
4.4 Cancellation procedures: Provides for termination of the agreement when the right to cancel is triggered by other provisions in the agreement, such as contingency and performance provisions. The method for any cancellation of this exchange agreement is controlled by this provision.
4.5 Exchange cooperation: Requires the parties to cooperate with one another in an IRS §1031 transaction on further written notice by either party. Provides for the parties to assign their interests in this agreement.
4.6 Liability limited on breach: To limit the liability of either party due to their breach of this agreement, enter the dollar amount representing the maximum amount of money losses the other party may recover due to the breach.
Editor’s note — Liability limitation provisions avoid the misleading and unenforceable forfeiture called for under liquidated damage clauses included in most purchase agreement forms provided by other publishers of forms.
5. Due diligence contingencies:
5.1 Satisfaction or cancellation: Enter the number of days in which the second party may terminate the exchange agreement after receipt of data on the first property that is unacceptable to the second party.
a. Operating documentation: Check the box to indicate the first party is to make his income and expense records and all supporting documentation available for inspection by the second party.
b. Rental rolls: Check the box to indicate the first party is to provide an itemized spreadsheet detailing all aspects of each tenancy in the property. [See first tuesday Form 380]
c. Natural hazard disclosure (NHD) statement: Check the box to indicate the first party is to prepare and provide the second party with an NHD statement disclosing the first party’s knowledge about the hazards listed on the form. [See first tuesday Form 314]
d. Physical condition of the property: Check the box to indicate the first party is to prepare and provide the second party with a disclosure of the first party’s knowledge about the physical conditions of the land and improvements which may have an adverse effect on the value of the first property.
e. Personal property inventory: Check the box to indicate the first party is to prepare an itemized list of the personal property he is to transfer with the first property.
f. Buyer’s inspection: Check the box to authorize the second party to carry out an inspection of the first property, himself or by his agents or consultants, to confirm the property’s value. Enter the number of days after acceptance in which the second party is to carry out the inspection.
g. Title conditions: Check the box to indicate the first party is to cause escrow to order out a preliminary title report for purposes of issuing a policy of title insurance on the first property and deliver the preliminary report to the second party as soon as possible.
h. Tenant estoppel certificates: Check the box to indicate the first party will prepare, mail and collect estoppel certificates from all his tenants to be delivered to the second party.
i. Tenant personal security: Check the box to indicate the first party will prepare a criminal activity and security statement disclosing his knowledge of crimes that affect the tenants’ use and occupancy of the property, and the steps he has taken or should take to provide personal security for the tenants.
j. Qualifying for §1031 exemption: Check the box to indicate the closing of the transaction is subject to the further approval of the second party’s tax advisors that the transaction qualifies for §1031 treatment.
k. Additional disclosures or investigations: Enter copy addressing any further information the second party wants in order to confirm expectations about the first property not covered in the boilerplate provisions of this form, such as investigations into zoning, use plans, permits or other governmental and private activities which may affect the property’s value to the second party.
5.2 Satisfaction or cancellation: Enter the number of days in which the first party may terminate the exchange agreement after receipt of data on the replacement property that is unacceptable to the first party.
a. Operating documentation: Check the box to indicate the second party is to make his income and expense records and all supporting documentation available for inspection by the first party.
b. Rental rolls: Check the box to indicate the second party is to provide an itemized spreadsheet detailing all aspects of each tenancy in the property. [See Form 380]
c. Natural hazard disclosure (NHD) statement: Check the box to indicate the second party is to prepare and provide the first party with an NHD statement disclosing the second party’s knowledge about the hazards listed on the form. [See Form 314]
d. Physical condition of the property: Check the box to indicate the second party is to prepare and provide the first party with a disclosure of the second party’s knowledge about the physical conditions of the land and improvements which may have an adverse effect on the value of the replacement property.
e. Personal property inventory: Check the box to indicate the second party is to prepare an itemized list of the personal property he is to transfer with the replacement property.
f. Buyer’s inspection: Check the box to authorize the first party to carry out an inspection of the replacement property, himself or by his agents or consultants, to confirm the property’s value. Enter the number of days after acceptance in which the first party is to carry out the inspection.
g. Title conditions: Check the box to indicate the second party is to cause escrow to order out a preliminary title report for purposes of issuing a policy of title insurance on the replacement property and deliver the preliminary report to the first party as soon as possible.
h. Tenant estoppel certificates: Check the box to indicate the second party will prepare, mail and collect estoppel certificates from all his tenants to be delivered to the first party.
i. Tenant personal security: Check the box to indicate the second party will prepare a criminal activity and security statement disclosing his knowledge of crimes that affect the tenants’ use and occupancy of his property, and the steps he has taken or should take to provide personal security for the tenants.
j. Qualifying for §1031 exemption: Check the box to indicate the closing of the transaction is subject to the further approval of the first party’s tax advisors that the transaction qualifies for §1031 treatment.
k. Additional disclosures or investigations: Enter copy addressing any further information the first party wants in order to confirm expectations about the replacement property not covered in the boilerplate provisions of this form, such as investigations into zoning, use plans, permits or other governmental and private activities which may affect the property’s value to the first party.
6. Property conditions on closing: Provides for the first and second parties to deliver up their properties at closing in a condition commonly expected of all properties bought and sold in California. These items are not those generally necessary to be confirmed as part of a due diligence investigation by the party acquiring title.
6.1 Structural pest control: Check the box if each party is to provide a report and certified clearance by a structural pest control operator on the property he conveys.
6.2 Improvement warranty policy: Check the box if each party is to furnish an insurance policy on the property he conveys for emergency repairs to components of the structures which are improvements on the property. Enter the name of the insurer who is to issue the policy. Enter the type of coverage desired, such as air conditioning units, water heaters, etc.
6.3 Local ordinance compliance: Provides for each party to furnish a certificate of occupancy or other clearances required by local ordinances on the property he conveys.
6.4 Safety law compliance: Provides for each property to meet smoke detector placement and water heater bracing required by state law.
6.5 Property maintenance: Requires each party to maintain the present condition of his property until the close of escrow.
6.6 Fixtures and fittings: Confirms this exchange includes real estate fixtures and fittings as part of the property acquired.
6.7 Further leasing and contracting: Requires each party to submit for approval (consent) by the other party all new or modified tenancy arrangements, service contracts and improvement alterations or equipment installation contracts relating to the property he is conveying.
6.8 Additional affirmative conditions: Enter any other conditions on or about the properties each party is expected to comply with prior to closing, such as obtaining permits, eliminating property defects, certification regarding components of the improvements on the properties, etc.
7. Closing conditions:
7.1 Escrow closing agent: Enter the name of the escrow company handling the closing.
a. Escrow instructions: Check the box to indicate the exchange agreement is to also serve as the mutual instructions to escrow from the parties. Typically, escrow companies will (or the broker will) prepare supplemental instructions needed to handle and close the transaction. [See first tuesday Form 401]
b. Escrow instructions: Check the box to indicate escrow instructions have been prepared and are attached to this purchase agreement. Attach the prepared escrow instructions to the purchase agreement and obtain the signatures of the parties. [See first tuesday Form 401]
7.2 Closing date: Check the appropriate box to indicate the manner for setting the date on which escrow is scheduled to close. Following the box checked, enter as appropriate the specific date for closing or the number of days anticipated as necessary for the parties to perform and close escrow. Note that prior to seven days before closing, the parties are to deliver all documents regarding the property they are conveying that are needed by third parties to perform their services by the date scheduled for closing.
a. Escrow charges: Provides for each party to pay their customary closing costs and charges, amounts any competent escrow officer can provide on inquiry. [See first tuesday Forms 310 and 311]
7.3 Title conditions: Provides for title to be vested in the name of the party acquiring the respective properties, or their assignees, subject to covenants, conditions and restrictions (CC&Rs) of record and mortgage liens agreed to in this exchange agreement.
Editor’s note — The inclusion of the preliminary title policy contingency at section 5.1g or 5.2g will control the CC&Rs to remain of record at closing, subject to exercise of the right to cancel the transaction if they are unacceptable to the party acquiring title.
7.4 Title insurance: Enter the name of the title company which will provide a preliminary title report and issue the title insurance policy. Check the appropriate box to indicate the type of policy to be issued.
a. Policy endorsements: Enter any endorsements to be issued with the policy of title insurance.
b. Insurance premium: Provides for the owner of each property to pay the premium for the policy insuring his conveyance.
7.5 Prorates and adjustments: Authorizes prorations and adjustments on close of escrow for taxes, rents, interest, loan balances, service contracts and other property operating expenses, prepaid or accrued.
7.6 Loan balance adjustments: Check the appropriate box to indicate the financial adjustment desired for loan balance adjustments brought about by any difference between the principal balance as stated in the exchange agreement at sections 1.2 and 2.2 and the amount stated in beneficiary statements from the lender on the date escrow closes.
Editor’s note — Often the parties will treat the equities as fixed and not subject to adjustments for variances in the balances of loans taken over by the new owner. Thus, loan balances adjustments are made into the “market value” of the property encumbered. More typically, the loan balance adjustments are made into any carryback note created in the exchange. Thus, the equity in encumbered property is adjusted to reflect a greater or lesser loan balance on the beneficiary’s statement than as stated in the exchange agreement. Adjustment into cash is seldom agreed to in exchanges.
7.7 Lease assignments: Provides for all leases and rental agreements to be assigned to the new owner on closing. [See first tuesday Form 595]
a. Change of ownership notice: Requires each party assigning lease and rental agreements to notify each tenant of the change of ownership. The notice eliminates any further liability to the tenants of the party assigning the agreements. [See first tuesday Form 554]
7.8 Personal property transferred: Provides for a bill of sale to be executed on any personal property to be transferred with the property.
a. UCC-3 clearance: Check the box if escrow is to order a UCC-3 condition of title report from the Secretary of State on the personal property being transferred by a bill of sale for approval by the party taking ownership of the personal property.
7.9 Fire insurance: Requires the party taking title to provide a new policy of fire insurance.
7.10 Possession: Provides for possession of the property to be transferred to the party acquiring title on the close of escrow.
7.11 Title failure and property destruction: Provides for the cancellation of the exchange agreement by the party taking title if marketable title cannot be delivered or the property improvements suffer major damage.
8. Brokerage fees:
8.1 Fees paid by first party: Enter the dollar amount of fees to be paid by the first party to his broker. Enter the name of the first party’s broker. If the fees are to be paid under a separate agreement, enter the words “per separate agreement” in lieu of the broker’s name.
8.2 Fees paid by second party: Enter the dollar amount of fees to be paid by the second party to his broker. Enter the name of the second party’s broker. If the fees are to be paid under a separate agreement, enter the words “per separate agreement” in lieu of the broker’s name.
8.3 Fees on default: Provides for the defaulting party to pay all brokerage fees due to be paid the brokers under section 8.
8.4 Fee-sharing arrangements: Authorizes the brokers to share the fees due them.
8.5 Transaction data disclosure: Authorizes the brokers to release information on the price of the properties and terms of the exchange to trade organizations and multiple listing services.
8.6 Agency Law Disclosure: Check the box to indicate an Agency Law Disclosure addendum is attached to the exchange agreement. Attach a copy of the addendum for all parties to sign if the addendum is to made a part of the exchange agreement. The disclosure is mandated on one-to-four unit residential transactions for enforcement of fee provisions by the brokers. [See first tuesday Form 305]
Agency confirmation:
First party’s broker: Enter the name of the broker who represents the owner of the first property making the offer to exchange. Obtain the signature of the broker or the agent acting on behalf of the first party’s broker. Check the appropriate box to indicate the nature of the agency created with the parties by the conduct of the broker and his agent.
Second party’s broker: Enter the name of the broker who represents the owner of the replacement property to whom this exchange agreement offer will be submitted for acceptance (or rejection). Obtain the signature of the broker or the agent acting on behalf of the second party’s broker. Check the appropriate box to indicate the nature of the agency created with the parties by the conduct of the broker and his agent.
Signatures:
First party’s signature: Enter the date the first party making the offer signs the exchange agreement. Obtain the signature of each of the persons who are the owners of the first property. Enter the first party’s name, address, telephone and fax numbers, and email address. Confirm that the parties signing this exchange agreement also sign all the attachments requiring their signatures.
Second party’s signature: Enter the date second party signs the exchange agreement offer. Obtain the signature of each of the persons who are the owners of the replacement property. Enter the second party’s name, address, telephone and fax numbers, and email address. Confirm that the parties signing this exchange agreement also sign all the attachments requiring their signatures.
Rejection of offer:
Should the offer contained in the exchange agreement be rejected by the second party instead of accepted, and the rejection will not result in a counteroffer, enter the date of the rejection and the names of the second party. Obtain the signatures of the second party.
Observations:
As the policy of the publisher, this exchange agreement does not contain clauses which tend to increase the risk of litigation or are generally felt to work against the best interests of the buyer, seller and broker. Excluded provisions include:
· an attorney fee provision, which tends to promote litigation and inhibit contracting;
· an arbitration clause, which, if included and initialed, absolutely waives the buyer’s and seller’s right to a fair and correct decision by trial and appeal; and
· a time-essence clause, since future performance (closing) dates are, at best, estimates by the broker and his agent of the time needed to close and are too often improperly used by sellers in rising markets to cancel the transaction before the buyer or broker can reasonably comply with the terms of the purchase agreement.
