1031 into LLC for a syndication

[John Retka]

I have a relative who is looking to 1031 out of their first rental. I have been thinking of creating a new LLC that would they could "contribute" to as part of their 1031 and combine that with my investment $$ and investment $$ from my 3 kids in the same LLC so that the new LLC can participate as an LP in an apartment syndication. Neither my relative nor my kids are sophisticated investors but I am. This would be my first syndication deal-I have a GP with a deal already picked out.

I seems from what I've read that I'm missing something in my thought process here. The operating agreement is one issue, but I'm really interested in whether or not I would be in violation of SEC rules to raise funds for the LLC to invest in the syndication.

TIA!

[Tal Shachar]

Hi @John Retka,

** I'm not a CAP/Tax strategist, nor a lawyer... **

I suggest you read the Book on Advanced Tax Strategies by Amanda Han & Matt McFarland, and check chapters 7,8,9 about 1031 exchange. What you are describing sounds like one of the common mistakes people do with 1031 exchange, which can and will cost you a lot.

Good luck with your adventure!

[Brandon Bruckman]

I'm also  

** Not a CPA/Tax strategist, nor a lawyer... **

In this case of syndication you are investing in a partnership, not an owner of actual real estate. You would need to use a tenant in common structure in the syndication to complete a 1031 exchange. A smart real estate lawyer could help you figure that out.  

[Evan Polaski]

@John Retka, there are several things going on here, that you really need to consult with an attorney.  

Generally, you are not syndicating if all the partners in your LLC have some level of say. If they are truly partners, and not limited partners with no say, this is just your typical partnership structure.

The second part is whether the LLC is able to invest in the syndication. Maybe you have explored this, but if the offering you are looking at is exempt under rule 506(c), all investors much be accredited. 506(b) offerings allow up to 25 sophisticated investors, that don't qualify as accredited and the GP must have a preexisting relationship with the investors. Jumping back to 506(c) offerings, the LLC is typically accredited with $5mm of asset value, OR all partners in the LLC are accredited individually. It sounds like you won't qualify there.

506(b) is self verified accreditation, and there is onus on the GP to confirm that they do not allow more than 35 sophisticated investors, have existing relationships with all investors, etc.  I cannot speak to the relationship side when it comes to multi-member LLCs, but again a lot of this falls more on the GP.

Lastly, you have the contribution of the property, and the ability to qualify for a 1031.  AND, the GPs willingness to accept 1031 proceeds into an offering.  Accepting 1031 proceeds requires specific structure on the front end and puts an ongoing burden on the sponsor that is actually running the deal and preparing tax returns.  it is clearly possible, but I would also be certain the GP has done this before, because there can be hurdles that if not handled correctly, have the potential to disqualify the 1031, creating a tax event.

Lastly, I will reiterate that I am not an attorney, CPA, qualified intermediary, or anything of the like.  So I highly recommend you talk to all of those listed to confirm this is all possible.

[John Retka]

One caveat to the story, the multi member LLC that I would be part would be investing as an LP in someone else's syndication. Does that change your thoughts at all?

[Bill Exeter]

The transaction that you are contemplating will not qualify for 1031 Exchange treatment. Your relative would be selling as an individual and then purchasing a membership interest (partnership interest) in the new LLC. A partnership interest is specifically excluded from 1031 Exchange treatment. You would have the same issue if you bought directly into the syndication (limited partnership). Your relative must sell a real property interest and must acquire a real property interest (not an interest in an entity) to qualify for 1031 Exchange treatment.

[Jim Pfeifer]

I will repeat what others have said ** Not a CPA/Tax strategist, nor a lawyer... **!

My first question is why do a 1031 Exchange?  I prefer the "Lazy 1031" - I sold all of my active real estate and now I am a passive investor in real estate syndications.  I did not pay any tax on the sale of my active real estate even though I had significant gains because I invested the proceeds in multiple passive real estate syndications.  The deals I invested in did cost segregations which gave me bonus depreciation and I was able to use these passive losses to offset the capital gains - the only part that requires any "doing" is making sure all of the transactions happen in the same tax year.  It isn't an exact science, because you won't know how much passive loss you generated until you get the K1s the following year, but you can make estimates and get pretty close.

I think others have answered the questions about going in with your kids. I do a lot of group investing through a platform called Tribevest. They make it easy to create an LLC, vote on investments and other issues (which makes everyone an equal active partner), fund investments through a connected bank account and store all documents. If one person in the LLC is not accredited, then the LLC is not accredited. I assume it's the same for sophisticated investors.

As others have said, I don't think you can combine 1031 funds with non-1031 funds in an LLC and still make the 1031 work. I don't really think that's a problem though because I think the 1031 is really not necessary in this instance.

Good luck!

[Dave Foster]

@John Retka,  There are ways to overcome just about everything in your scenario except for the ultimate purchase of the LP position in a syndicate. Unless they can sell to you a tenant in common interest of the actual real estate in the syndication it won't qualify for 1031 treatment.  

But if you eliminate that last step it might be very possible to pool the money from your kids and you and purchase a property that is also a replacement for your relatives 1031. Then contribute the property into a new LLC. And voila you have a mini-family syndication.

[Lane Kawaoka]

In 2018 I sold 7 sfhs and had 200k of capital gains. I just offset it with 200k of passive losses that I built up by going into syndications.

The 1031 exchange is a method of pushing forward the taxes due on the capital gains of a property. You have 45 days to identify replacement property that 180 to close on said property(s).

Its a way of kicking the can down the road with taxes. I would use a 1031 in the last case resort since you have to pay taxes at some point unless you are going to take it to the grave with you and get the step up basis (so there is an exception if you are pretty sure you are on your last 5-10 years of life) which is not very practical due to the following.

1) The 45 days is almost impossible to execute. To be able to line up a deal that is “hot”. Experienced investors spend an average of 18 months to find that elusive first apartment. Now if you are buying lukewarm deals… then be my guest. But in this seller's market, I think its a way to lose everything. Again when you sell the asset in 5-10 years anyway you will be in the same but worse predicament. Take advantage of bonus depreciation now.

2) Most investors that I work with are high net worth and able to cashflow income minus expenses over $30k a year and have over 50K of liquidity on hand. I believe that most people, unless they are talented at being an elite investor, should just be an LP role in a syndication due to the scalability and being able to spread their capital across different leads, business plans, asset classes, and geographical locations. That said a 1031 exchange will not allow you from going from real property to an LLC (ownership in a syndication). Although you could do what is called a Tenant-In-Common (TIC) arrangement where an investor has 1031 exchange funds and wants to parlay that money into a syndication. It's possible but from the syndicator's perspective a lot of unneeded work when you can just raise the funds the traditional way.

The order in which suspended losses are deducted is:

1. To first offset depreciation recapture and gain from the activity that was sold.
2. If the suspended losses are in excess of the total gain, the remaining suspended losses will then offset ordinary income.
3. If the suspended losses do not offset 100% of the gain from the activity that was sold, you may use suspended losses from other rental activities to offset the remainder of the gain from sale.

This is detailed in IRC Sec. 469(g)(1)(A). And if you want to have a wild Sunday night, here's an article that explains it in-depth:

https://www.thetaxadviser.com/...