1. The investor can elect not to include the note in the 1031 exchange.  The investor would be listed as the beneficiary on the note at the closing of the transaction and would pay taxes on the note over time as described under the installment sale provisions under Section 453 of the Internal Revenue Code, or
2. The investor can include the note in the 1031 exchange.  In order to accomplish this, at the closing of the sale, First American Exchange Company must be listed as the beneficiary on the note.  Under this method, the client has numerous choices regarding how they can relieve themselves of the note through the 1031 exchange process, and still defer their capital gain liability.  In any event, the investor must either use the note to buy the replacement property or convert the note to cash before acquiring the replacement property in order to be able to get 1031 tax deferral on the value of the note.   

• The investor could use the note as a partial payment on their replacement property. To do this, the investor must find a seller who is willing to take the note as consideration towards their purchase price. The note would be assigned from First American Exchange Company to the seller at closing.
• The note may be paid off by the buyer of the relinquished property before the investor purchases replacement property. This option only works when the note is due to be repaid in less than 180 days. In this case, the buyer pays off the note directly to First American Exchange Company, the holder of the note. First American Exchange Company receives these funds and deposits them into the investor's 1031 account, giving the investor cash to purchase their replacement property.
• The investor can acquire the note by depositing cash with the settlement agent equal to the amount of the note on or prior to the date the replacement property closes.  At the closing, the note will be assigned to the investor and the cash used to buy the note will be available to acquire the replacement property. 
• The investor may sell the note on the secondary market.  If the investor can find someone who is willing to purchase the note from First American Exchange Company, First American assigns the note to the buyer of the note, and the buyer deposits cash into the investor's 1031 account.  Normally, an investor who will purchase the note will purchase it only at a discount, sometimes 20% - 30% below the note's value.  If such a discount occurs, some tax professionals will classify the discount as a selling expense.

If an investor initially chooses to have the carryback note payable to First American Exchange but is unable to convert the note to cash or use it to acquire the replacement property, at the end of the exchange, First American Exchange Company will assign the note to the investor.  The investor will receive payments under the note and the applicable taxes will be due upon receipt of each payment.  Some of these payments may be taxed under the installment sale provisions of Internal Revenue Code Section 453, so please consult with your tax professional for specific information.