Client Sells a property (which was owned by his LLC #1). LLC #1 then takes the proceeds and distributes it to LLC#2 which is fully owned by LLC#1. LLC#2 uses the funds to purchase a property a complete the 1031 exchange.
An qualified intermediary has been involved and all is documented properly.
Here's where it gets confusing.
When LLC#1 sold the property it had a deferred gain of $1,000,000 of the sale of a property for $2,000,000.
LLC#1 did not send the whole $1,000,000 to LLC#2. It sent $500,000. LLC#2 then used the $500,000, together with mortgage to purchase a new property for $2.5m, this way completing the 1031 exchange.
ON the books of LLC#1 I have a deferred gain of $1M. HOw am I reducing that when the exchange is complete?
Right now I have it as no deferred gain and a negative investment in LLC#2 for $500,000 ($500,000 actually invested - $1,000,000 deferred gain = -$500,000).
Is this correct? can anyone shed some guidance?
Or, I guess another way to ask this question is...... if you purchase a new property for more than you sold the old property, but you do not use the cash to purchase a new property, you go out and get financing for the new proeprty, is that a problem?
My first suggestion would be to talk with your CPA and RE attorney, although if the deal is already done then you can't go back and change anything.
In answer to your last part of the post, it's not a "problem" if you don't use all of the proceeds from the sale toward the purchase of the replacement property however any money that is not used will be taxed as a capital gain.
I have done one 1031 exchange and this is my understanding. I'm not a CPA or attorney, and your situation is much more complex so again, I would recommend starting with your CPA.
Best of luck.
@Eric Black is right- whatever isn't rolled into the investment of a new property is taxable.
I'm an accountant, but I'm not YOUR accountant. This advice is provided for informational purposes and is no substitute for advice from a competent accountant familiar with the details of your situation. By using this advice, you agree to limit my liability to how much you paid for it (that's $0, btw). Have a nice day.
Since LLC-1 is not the owner of the replacement property purchased with the exchange proceeds from the sale of the relinquished property, it would appear that the entire exchange has failed and LLC-1's sale of the relinquished property is a fully taxable event.
Someone with expertise in this area and with full knowledge of all documented details of the legs of the transaction will have to give you a definitive opinion. However, to this casual observer, it seems that the exchange failed and none of the profit nor none of the unrecaptured depreciation is deferred.
Dave T I think, though I'm not positive, that if LLC2 is a *wholly owned* sub of LLC1 (as OP describes) and 2 uses 1's EIN, then the difference is academic and the 1031 is successful. What I think really matters is the tax-reporting entity, which would still be LLC1.
It sounds as though LLC 2 will be treated as a single member limited liability company that is 100% owned by LLC 1 and therefore a disregarded entity to income tax reporting purposes. If this is true and LLC 2 is truly a disregarded entity, then the acquisition of the replacement property by LLC 2 will be treated as if it was acquired by LLC 1 and will qualify for tax-deferred exchange treatment under Section 1031.
The $500,000 cash that was not invested is considered taxable cash boot.
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