How does seller financing work inside a 1031 exchange?

1031 mechanics, debt replacement, and how seller financing affects boot

1031 baseline: per IRS Section 1031, like-kind exchange of real property held for investment defers gain recognition, subject to identification (45 days) and close (180 days) windows, qualified intermediary (QI) holding of proceeds, equal-or-greater value at replacement, and equal-or-greater debt at replacement. Failure on any of these elements creates partial or full taxable boot.

Seller financing on the relinquished property: when the seller of the relinquished property carries back a note from the buyer, the carry-back balance is technically not cash received. Per IRS rules, the QI typically cannot hold a buyer's note (it must hold cash or near-cash). Most commonly, the seller carries back the note in the seller's own name (outside the QI), which means the carry-back balance is treated as boot received unless installment-sale treatment under Section 453 applies.

Installment-sale interaction: if the seller-carryback meets installment-sale requirements, gain on the carry-back portion may be deferred to receipt of payments. This works alongside 1031 only with careful structure, installment-sale + 1031 elections require CPA coordination and are not the default. The QI must agree to the structure.

Debt-replacement on the replacement property: the exchanger acquiring the replacement property must hold equal-or-greater debt at the replacement property to satisfy the 1031 debt-replacement test. If the buyer of the replacement property is also using seller financing or assumable senior plus seller second to buy in, debt-replacement still must equal-or-exceed relinquished-property debt, additional cash can cover a replacement-debt shortfall. That cash offsets mortgage boot. It does not create boot.

Timing coordination: 45-day identification and 180-day close windows are absolute. Seller financing on the buy side requires the seller-carryback note to be funded at replacement close; any closing delay past day 180 fails the 1031. QI, exchanger's counsel, replacement-property seller's counsel, and CPA must coordinate from the relinquished-property close through replacement close. Not tax advice.