Contracts and Your 1031 Tax Exchange Transaction

What are the essential elements of a contract? There are various contracts that have to be set in order to complete a successful 1031 Tax Exchange transaction. These include, but are not limited to, a purchase and sale contract, a listing agreement, an escrow contract, a contract with a qualified intermediary and various contracts with financial institutions.

A contract is, “ An agreement between two or more parties, preliminary step in making of which is offer by one and acceptance by other, in which minds of parties meet and concur in understanding of terms.” (Lee v. Traveler’s Insurance Company, 173 S.C. 185, 175 S.E. 429)

Some of the necessary elements that make up a contract are;

·         Promise. In a 1031 Tax Exchange or any other real estate disposition, the seller promises to transfer title to their relinquished property to the new buyer. The new buyer, in turn, promises to pay the negotiated price. All contracts must contain a promise.

·         The parties involved in the contract must be legally capable of entering into a contract. First off, the seller in a 1031 Tax Exchange must have the legal right to sell their relinquished property. They must hold title to the property or have the authority to act on behalf of the title holder (as in the case of a corporation, or guardian of minor). They also must be of legal age to contract and be legally sane.

·         Consideration. Another important element of any contract is that it must be supported by something of value, or some consideration. The most commonly used form of consideration is money. In typical 1031 Tax Exchange transactions, money is offered as consideration in exchange for the deed to the property. Although money is the most commonly used form of consideration, anything of value can be used. Personal property, for example, can be an easy substitution.

·         Lawful object. The promises and the consideration mentioned above must be lawful in order for the contract to be enforceable by law. In California, for example, a contract that uses gambling debts as consideration can not be enforced because gambling is illegal.

·         Mutuality. Mutuality means a meeting of the minds. This is when both parties in a contract agree to the terms of the contract and both have the same interpretation of its meaning. Often times contracts can be vague in certain areas, and this causes confusion between parties.

The form and accuracy of contracts is also very important. In a 1031 Tax Exchange transaction it is  important for both buyer and seller to sign the contract, and the clarity and precision of instructions are of extreme importance.