1031 Exchange

12 Replies

Hi 

I am newbie and wanted to find out if you sell a residential property that is titled under an LLC can you use the 1031 exchange for capitol gains exemptions?

Kind Regards,

Stephanie

As long as your intent when you bought the property was to hold it as an investments, yes, you can do a 1031.  You can't use 1031 exchanges for properties bought for non-investment purposes (e.g., fix and flip, wholesale, spec builds.)  And you can't use 1031's on a house you occupy.

Stephanie you need to keep the same tax ID number going into the new property or properties. Before contemplating an exchange there are plenty of 1031 companies on here. You might want to give them a call about your specific situation.

No legal advice.

Thank You Jon and Joel for your prompt replies!!

Very helpful info!!

Kind Regards,

Stephanie Zito

Hi @Stephanie Zito yes you can structure a 1031 Exchange transaction when the property is owned by an LLC as long as the property was held for rental, investment or business use. Properties held for personal use or for sale such as a rehab/fix/slip will not qualify for 1031 Exchange treatment. Also, we would need to take a proactive look at how you intend to acquire and hold title to the replacement property to ensure that there are no problems created by the way you will hold title to the subsequent investment property.

Hi Stephanie,

Lot's of good thoughts floating around here but to get a little more specific to your question, the real issue is that while any tax paying entity can do a 1031 exchange the taxpayer for the relinquished (old) property has to be the same as the taxpayer for the replacement (new) property. Although title is certainly one piece of that evidence, the real test is who files taxes for the piece of property. If your LLC is a multiple entity multiple asset LLC filing it's own return then somewhere you have a form 8832 that elects how your LLC is treated. In that case the LLC is viewed as the tax payer for the property and the LLC must purchase the replacement property.

However, if your LLC does not file it's own return it is what is known as a disregarded entity. The IRS recognizes it's existence for whatever benefits the issuing state might give but the underlying property is only reported on your individual schedules. That in effect means that although the LLC may be on the deed, you are the actual tax payer. In this case you've got a lot more flexibility on how you structure your exchange.

No need to go to a lot of expense, just a quick glance at your tax return's schedule E or a call to your accountant will verify and then you can proceed with your 1031 as appropriate.

Thank you so much Bill and Dave for this great information!!!! 

It is greatly greatly appreciated!! 

Kind Regards,

Stephanie Zito

@Bill Exeter   Is there a minimum amount of time the previous property needs to be used as an investment property? Does it need to be an investment property immediately preceding the transfer? Also, is there a minimum/maximum amount for the 1031 exchange? 

Sorry for all the questions but figured I would just put them all out there :)

Hi @Kyle Kelley  

The code and regulations do not have any specific or minimum required holding period in order to qualify for 1031 Exchange treatment.  The real issue is whether you have the intent to hold for rental, investment or business use. The investor would have to demonstrate that they had the intent to hold for rental or investment purposes should they get audited. 

Most advisors and experts recommend a holding period of at least 12 months, but the holding period is only one part of the equation.  Auditors would look at many things to determine what the investors intent is/was.  There are cases where an investor held property for years and then sold and structured a 1031 Exchange, but the investors intent was to always build and sell, so their 1031 Exchanges were still disqualified.  So, while the holding period will help demonstrate intent, it is not the only item that matters.  The intent is the true test.

@Bill Exeter   et al.

After reading these, I'm curious how 1031 applies to my situation. I've setup an appt with a new cpa (if the interview goes well) but I am curious what the BP community thinks?

I am planning on doing a 1031 on a 2010 sfh purchase next summer 2015 (I lived there for 11 months before becoming an accidental landlord/investor).

I want to use the "total revenue" from the sale (after paying off lender) to :

1. buy another sfh home (and move in) 
2. buy a duplex/multifam (and move in) and rent out other unit(s).
3. buy another sfh home (and move in) and save the balance cash in the bank.

4. buy another sfh home (and move in) and use balance cash to rehab before move in..
5. buy a duplex/multifam (and move in) and rent out other unit(s) and save the balance cash in the bank.

6. buy a duplex/multifam (and move in) and rent out other unit(s) and rehab before moving in, and finally save the balance cash in the bank.

Are any of the numbered above hypothetical scenarios possible/legal for 1031?

Note: I added all these extra scenario that the "total revenue" can't purchase..but what if...

Thanks.

Originally posted by @DJ Sule:
I want to use the "total revenue" from the sale (after paying off lender) to :
1. buy another sfh home (and move in) 

This does not qualify because the replacement property would not be "Qualified Use" property under Section 1031.  The property would have to be held for rental, investment, or business use, but can not be used personally as a primary residence, second home or personal vacation home.

2. buy a duplex/multifam (and move in) and rent out other unit(s).

This is possible as long as the fair market value of the percentage/portion of the replacement property that is held/used for rental is equal to or greater in value than your net sale price.  For example, let's assume that you sell your property for $500,000 and your routine selling expenses are $25,000 so that your net sale price is $475,000.  Let's further assume that you buy a duplex as your replacement property, which is worth $900,000.  The duplex is held half for rental and half as your home (e.g., you rent out one half of the property and you live in the other half).  This would qualify because the value of the half that you rent out is $450,000 (it would be greater than this due to purchase expenses), which is greater than the $475,000 net sale price.

3. buy another sfh home (and move in) and save the balance cash in the bank.

This would not qualify.  See the response to item number one above.  It would not satisfy the Qualified Use requirement.

4. buy another sfh home (and move in) and use balance cash to rehab before move in..

This would not qualify either.  See number one above.


5. buy a duplex/multifam (and move in) and rent out other unit(s) and save the balance cash in the bank.

I am assuming that you would trade equal or up in value, so the only issue here is that you are keeping some cash.  Cash left over (i.e., not reinvested) is taxable boot. 

6. buy a duplex/multifam (and move in) and rent out other unit(s) and rehab before moving in, and finally save the balance cash in the bank.

I think I've covered this item in the above answers. 

Are any of the numbered above hypothetical scenarios possible/legal for 1031?

Note: I added all these extra scenario that the "total revenue" can't purchase..but what if...

Thanks.

DJ,,  As several have mentioned above - "intent to use for productive use in business, trade, or for investment" is the key to whether your exchange will be he held if examined.  

I think there is at least one alternative scenarios available to you depending on level of flexibility on your part that has been overlooked so far.

 Remember that intent and use when the property is purchase are the key to defending your exchange.  As several have said there is no statutory minimum holding period either before or after the exchange is accomplished.  There is only the question of intent.  And while intent can be satisfied in part by holding longer rather than shorter it is no longer the gold standard for qualification.

 If you have the ability to be patient about moving into the residence you buy with your 1031 you may still be able to accomplish your 1st scenario.  It's called a 121-1031 conversion and we do quite a few of them actually.

 The scenario runs like this - You sell a piece of qualifying (as determined by your intent and use of the property) and 1031 exchange to another piece of qualifying (as determined by your intent and use of the property).  After a period of time in qualified use you change your mind and "convert" the property to primary residence.  

Once this is accomplished then it becomes sec 121 property and the same primary residence tax free exclusion is available to you on this property as with any property with two additional requirements.  You not only have the standard requirement of having lived in the property for 2 out of the previous 5 years before you can sell and take the tax free exemption.  In addition to that, because the property was originally a product of a 1031 exchange you also have to recapture depreciation taken and have owned the property for a total of 5 years before you can sell it and take allowed profits tax free.

the beauty of this is that it turns tax deferred profit into tax free profit and does have the sanction of being addressed in IRS Rev. Proc 2005 - 14 and further codified in  Rev Proc. 2007 - 12.  What is difficult is that it requires you to delay moving in to the property immediately.  And it doesn't specify how long you have to wait to do so.  Conservative thinkers will feel comfortable using the term two years.  Conventional wisdom has long chanted the mantra "one year and one day" (but for very different reasons than you might think.  The reality is that no one really knows for sure because intent and use are the key.  But longer is better than shorter.  It really comes down to what you and your legal and financial advisors feel comfortable with.

And it may not be right for you but patience can pay off.

Dave

Thank you very much. This is a lot of food for thought.  Excellent responses @Bill Exeter   

and @Dave Foster