Active Under Contract in Real Estate: What It Means for Your 1031 Exchange

Active Under Contract refers to a real estate property with an accepted offer that may still accept backup offers. The status indicates that the property is progressing toward closing but has not yet been officially sold. The property remains on the market during this period, and some sellers may still allow backup offers. Real estate investors engaged in a 1031 exchange need to be aware of this status when identifying replacement properties in their 45-day period. 

This article will explore how properties that are active under contract impact 1031 exchanges, strategies for navigating them, and potential risks. 

What Does ‘Active Under Contract’ Mean?

Active Under Contract indicates that a seller has accepted an offer but is keeping the listing active, allowing for backup offers. They cannot agree to a separate contract for the same property with another buyer. This labeling will show up on real estate websites and Multiple Listing Services (MLSs), which are exclusive databases established, managed, and funded by real estate professionals (such as a real estate broker) to assist their clients in buying and selling properties.

Why Properties Are Labeled ‘Active Under Contract’

Both buyers and sellers can benefit from an Active Under Contract label. For buyers, it allows for the transaction to fall through based on contingencies such as financing, inspections, or selling another property.

For sellers, they may prefer to keep options open in case the deal falls through, since some sellers may still allow backup offers.

Difference Between ‘Active Under Contract’ and Other Listing Statuses

Real estate listings include various statuses that indicate whether the property listed is pending, in a contingency period, or available. A real estate agent or other professional with access to a local or regional MLS can view official property listings; however, nowadays, these statuses/listings are almost immediately available to potential buyers on large real estate websites.

Here are the options for MLS listing statuses displayed:

• Pending: The property is under contract with no backup offers allowed.
• Contingent: Sale depends on certain conditions being met (e.g., appraisal, secure financing, inspection).
• Available: The property is fully open for offers with no current contract in place.

How ‘Active Under Contract’ Status Impacts 1031 Exchanges

A 1031 exchange, also known as a like-kind exchange, is a tax-deferred exchange that enables real estate investors to postpone capital gains taxes when exchanging one investment property for another. Named after Section 1031 of the IRC tax code, this strategy allows investors to reinvest proceeds from the sale of a relinquished property into a like-kind property.

To fully defer capital gains taxes, the replacement property must:

1. be of equal or greater value than the one sold and 
2. all proceeds from the sale must be reinvested. 

[Insert graphic that explains “like-kind” properties]

Following this stipulation ensures that 100% of the taxable gain is deferred. However, there are requirements. For example, an investor has 45 days from the date of the sale of the relinquished property to identify replacement properties. After the 45-day identification period, the exchanger has an additional 135 days (for a total of 180 days from the initial sale) to complete the acquisition of the replacement property or properties.

Why ‘Active Under Contract’ Matters for 1031 Exchanges

There are exceptions to the 180-day rule; however, the IRS may grant extensions in cases of federally declared natural disasters, terrorist or military actions, or for individuals serving in the U.S. armed forces in a combat zone or supporting such forces. This means that the Active Under Contract status truly matters for 1031 exchanges because: 

• The replacement property must be acquired (ownership transferred) within the 180-day timeframe
• Properties under contract may not be available within the 180-day timeline
• Losing a selected replacement property could result in failed exchange penalties and tax liabilities.
  

Potential Risks of Selecting an ‘Active Under Contract’ Property

The real estate market is subject to local and global economic changes and therefore comes with some inherent risk to the investor. Submitting an offer on an Active Under Contract property could potentially increase risk. 

The property’s closing date may occur before the investor can secure necessary financing, potentially jeopardizing the closing. The general uncertainty could delay the 1031 exchange process, and if the investor doesn’t secure a replacement in time, they risk triggering a taxable event from a failed exchange.

Strategies for 1031 Investors Dealing with ‘Active Under Contract’

Investors should use key strategies to successfully navigate properties under contract and keep their exchange on track.

Submit a Backup Offer

Many real estate transactions fall through due to financing issues, inspections, or buyer hesitation. Submitting a contingent backup offer helps ensure priority if the initial deal collapses. 

Identify Multiple Properties

The IRS provides three options for identifying replacement properties in a 1031 exchange:

1. The Three-Property Rule: Investors can identify up to three replacement properties, regardless of their value, as long as they purchase at least one.
2. The 200% Rule: If selecting more than three properties, the total value of all identified properties cannot exceed 200% of the relinquished property’s market value.
3. The 95% Exception: Investors can identify any number of replacement properties, regardless of their combined value, as long as they ultimately acquire replacement property(ies) whose aggregate fair market value is at least 95% of the aggregate fair market value of all the identified properties.

This process allows investors to diversify their selections and avoid reliance on a single property, meaning bidding on an ‘Active Under Contract’ property description is less of a risk.

Work with an Experienced Qualified Intermediary (QI)

Collaborating with a qualified intermediary (QI) is essential during the 45-day identification period. Investors must submit a written identification of the replacement property to the QI, also known as an exchange accommodator, by midnight on the 45th day. They must include the addresses and descriptions of the properties they intend to acquire. 

An experienced QI is crucial for ensuring compliance with IRS guidelines and properly managing the exchange funds. They also prepare the necessary documentation to establish the investor’s intent to initiate the 1031 exchange and hold the funds securely until the exchange is complete

Consider a Delaware Statutory Trust (DST) as a Backup Option

DSTs are a popular replacement property option for 1031 exchangers because they qualify as replacement properties and offer fractional ownership in institutional-grade properties. These legal entities provide an alternative if primary property selections fall through

Key Considerations for 1031 Investors

A successful 1031 exchange requires careful planning and awareness of critical factors that can impact the transaction.

• Time sensitivity: If a property under contract is sold to another buyer before an investor completes their exchange, it may disrupt the transaction.
• Market conditions: Competitive real estate markets may have limited available properties, making backup strategies critical and potentially effective.
• Due diligence: Research whether the property has contingencies that may lead to contract termination, creating an opportunity for backup buyers. Prospective buyers may or may not have access to information on contingencies, but it’s important to investigate. 

Handle ‘Active Under Contract’ Listings with Confidence

Active Under Contract properties can be both an opportunity and a risk for 1031 investors. It’s important to understand the value and risk of making backup offers, along with the 1031 exchange requirements.

1031 Crowdfunding provides a comprehensive solution for investors facing replacement property challenges. Our platform offers a curated selection of 1031 qualified investments, along with guidance from our dedicated team of real estate experts, ensuring a smooth and successful exchange process. Discover the 1031 Crowdfunding advantage today.

This material does not constitute an offer to sell or a solicitation of an offer to buy any security. An offer can only be made by a prospectus that contains more complete information on risks, management fees, and other expenses. This literature must be accompanied by and read in conjunction with a prospectus or private placement memorandum to fully understand the implications and risks of the offering of securities to which it relates. As with all investing, investing in private placements is speculative in nature and involves a degree of risk, including loss of your principal. Past performance is not necessarily indicative of future results, forward-looking statements and projections are not guaranteed to achieve the results described, and your actual returns may vary significantly. Investments in private placements are illiquid in nature, and there may be no secondary market or ability to sell the investment should the need for liquidity arise. This material should not be construed as tax advice, and you should consult with your tax advisor, as individual tax situations will vary. Securities offered through Capulent, LLC Member FINRA, SIPC.