1031 Exchange For SoloK Property

[Alan Williams]

Modeling a potential [transaction] scenario and would appreciate feedback/insights on legal and/or tax implications as well as whether each of the options for the overall transaction makes sense ...

Property 1 is valued at > $1MM and is owned by a SoloK [proportionately] FBO of two Co-Trustees. There is no mortgage on the property as it was acquired in an All-Cash transaction. Ordinary Income Taxes on the distribution of the property to the Co-Trustees at the time they tax possession in Tax Year 3 are projected to be $300K. Property is deeded to LLC 2 under the Holding Company LLC, LLC 1.

Property 2 is valued at > $400K and is owned by a Partnership consisting of the same two Co-Trustees, the two Plan Participants of the SoloK Plan that acquired Property 1. Taxes on a taxable sale of the property by the Partners are projected to be [long-term Federal and State] $137K with net proceeds of $300K. Property is deeded to the Holding Company, LLC 1.

The transaction goal is to minimize long-term capital gains taxes due on Property 2 while paying the projected Ordinary income taxes due on Property 1 using the net proceeds from sale or exchange of Property 2 all while deferring actual tax payments to the maximum extent [via extensions].

Assuming 2023 is Tax Year 1 ...

Option 1: 

Execute a taxable sale of Property 2 in Tax Year 2, pay the long-term capital gains taxes due from Tax Year 2 in Tax Year 3. and use the net proceeds of $300K to pay the projected taxes due upon taking possession of Property 1 in Tax Year 4.

Option 2: 

Execute a 1031 exchange of Property 2 to Property 1 using the net proceeds of > $400K to purchase x% of Property 1 (i.e. > $400K / >$1MM) in Tax Year 2. Revise the Deed to reflect the new ownership percentage between LLC 2 and LLC 1.

In Tax Year 2 take possession of Property 1, with the distributed value reduced by the amount owned by LLC 1, pay Ordinary Income taxes on the net distribution and revise the Deed to reflect 100% to LLC 1 with the two Co-Trustees being the 100% Beneficial Owners.

Essentially, Option 2 could potentially shield an additional $100K+ used to purchase Property 1 from capital gains taxes via a 1031 Exchange. 

It would appear Option 2 could be Self-Dealing per IRS guidelines but at the time of the transaction Property 1 is owned by a SoloK Plan and Property 2 by a completely separate LLC -- however, does this matter given the Co-Trustees, Plan Participants and Beneficial Owners of the LLC are all the same Persons ?

Best to All -

Thanks