Complex 1031 Exchange Question--Please Help!

12 Replies

Hi to all you tax know-it-alls and 1031 exchange folks. With anyone who has experience in the field, I am really in need of your detailed advice concerning this deal I have going on. Please see below:

In September of 2014, I purchased a 4-unit building as a long-term hold in my personal name ("MANSHIP,CLAY"), to add value and increase rents as tenants rolled. However, as tenants moved out in the spring, a trend in the market allowed for these units to each be flipped and subdivided as luxury condo units. As I started to begin this process with an empty building, another local investor approached me an offered me a favorable price to sell and walk away from the deal. This would result in about $50,000 in equity for me to play with.

However, it is important to realize that, behind the scenes, my business partner (twin brother) and I own this project 50/50--although it is currently owned in my own personal name. We have an LLC where we are each 50/50 partners, and ideally would like to quitclaim the property to this entity, sell the property, and then 1031 all of the $50,000 proceeds into the two new properties that we would then be identifying.

Further, my partner/brother and I have already identified two new properties that we will be rolling the proceeds into. They are identical side by side duplexes not far from the property we are selling. I would be putting the property I am purchasing in my own personal name, and the same would go for him. Our targeted closing date is on July 31, 2015.

My question is this:

Is there a way for my brother and I to both benefit from a 1031 exchange here, although the property is currently titled under my own name? If I were to quitclaim the property to our LLC, would we then be able to split up the equity (as we will be anyway) and tax-defer the proceeds and roll them into the properties we have already identified? Below is our ideal scenario:

Total Sales Price: $135,000

Total Equity Gain: $50,000

Each Partner's Share: $25,000

1. Realize and Pay Tax on $12,500

2. Roll and 1031 Exchange $12,500 on property that is currently under contract

The same exact scenario would go for my brother/partner. Any help would be appreciated--looking to see what the best course of action here is, and need to start soon! Happy to provide any other information that might be necessary as well. Please and thank you!

Do not pass go, for a couple of reasons.

You bought as an owner occupant, which is how you got the203k loan; personal residence doesn't qualify.

Your time period is too short to make it a "long term investment". Same goes for transferring to an LLC, it would have to show this as a long term investment, before doing a 1031.

Acquired property(s) have to be in the same name as the entity selling the first property.

Hey @Wayne Brooks -

The property was not purchased with me as an owner occupant, nor was it purchased with a 203k loan. I had considered living it in at one point, but viewed it as a better investment and bought it with cash as a long-term income producing property.

I understand the transfer to an LLC and time horizon concerns--that's why I'm here. If I am going to be taking the proceeds from the sale (if we decide to go through with it) and push them into these new properties we are buying, it seems stupid to pay capital gains taxes at the moment if we don't have to. Just trying to get a feel for where we stand and what our options are.

My bad, had this 4 plex confused with another one I guess...someone did "a diary of a 203k...", thought it was you.  Perhaps if you simply he do it for for another year or so then did a1031 in just your name, you and your brother could figure out how to divvy it up later.

Hi Clay,

If I understand the post correctly, you and your brother acquired the property with the intent to hold for long-term investment purposes, but legal title is held only in your name  even though you and your brother technically own the property 50/50 as individuals.  Correct?  Did you each report 50% of the investment property ownership on your individual tax returns? 

One of the most important elements in order to qualify for 1031 Exchange treatment is your intent to hold the property for rental, investment or business use purposes.  You clearly had the intent to hold, but you have a short-term holding period, which can make an audit more difficult to prove that you had the intent to hold for rental/investment purposes. 

Contributing the property into the LLC, which is owned by the two of you and therefore treated as a partnership for tax purposes, would further complicate your ability to prove that you each individually had the intent to hold for rental/investment purposes and the partnership would likely not be able to prove that it had the intent to hold for investment purposes. Remember that the LLC is a completely separate legal entity. It is not the same as you and your partner.

You should have your accountant review the entire scenario to ensure that the ownership is truly owned by each of you on a 50/50 basis for income tax purposes.  I would then quit claim deed the property into both names so that legal title reflects the true ownership.  Run this by your attorney first to make sure that you are not creating other problems.  I would then structure two (2) 1031 Exchanges, one under each of your names as individuals so that you can each exchange into what ever properties you so choose.  You can buy together, or you could buy separately. 

There are many moving parts here, so it is important that you run the entire situation past your legal and tax advisors before you proceed in order to prevent further complicating your situation.

@Clay Manship

I agree with others - your intent is solid and you have the added benefit of having this process go across two tax reporting years.  But yes it is a short hold.

I don't think it's wise to do anything deed wise with that property prior to the sale. For the same reason that quit claiming it to your LLC "complicates" the proof of intent issues, Quit claiming it into both your names does exactly the same thing. Plus from the sounds of it your brother was a silent partner in the financing and is probably also on the expense side which would require amended returns and a whole level of transparency that could cause you difficulty.

The easiest answer is for you to complete one (not two) 1031 exchanges and have you buy both of those properties in your name. After the dust settles on that then work with your cpa and have you contribute those properties to the LLC so that you and your brother are now 50 50 in them. If you ever have to dissolve the LLC at that point then allocating the assets of the LLC to each individual member becomes a much easier manner.

In order to complete a legal 1031 exchange, the property you are purchasing must be in the same name as the property you are selling. So if you own the property now in your own name, you must buy the replacement property in your name. You could certainly go through the whole LLC deed transfer and hope that the IRS doesn't challenge the exchange and you may very well prove your case but you may not. Are you going to spend $5K for a CPA to defend your position to the IRS? Are you qualified to defend yourself to the IRS? Is it all worth it? It seems like a lot of work for a $50K gain between two people that you could very likely reduce through some "creative accounting". I don't think it's all worth the effort to complete the exchange. Move on to bigger and better things @Clay Manship . You don't want to be on the radar of the IRS now or in the future...

I don't completely agree with some of the posts above.  If you both agreed to buy the property together, and you have both treated, accounted and reported the property as 50/50 ownership, the fact that you hold legal title in your name does not necessarily mean that the property is therefore 100% yours.  There are many reasons why groups of investors or partnerships may designate a sole person to hold title on behalf of the group or partnership.  It is not as black and white as who holds legal title.  There are other moving parts that must be considered before making a decision on what to do and how to handle it. 

Bill- I'm afraid that when it comes to a 1031 exchange, title is very black and white.  I don't believe the IRS cares about "intent"- the entity purchasing the acquired property must be the same as the entity that owns the relinquished property.

Originally posted by @R J Drahcir:

Bill- I'm afraid that when it comes to a 1031 exchange, title is very black and white.  I don't believe the IRS cares about "intent"- the entity purchasing the acquired property must be the same as the entity that owns the relinquished property.

I'm sorry, but there are plenty of IRS Rulings and Court decisions that say otherwise.  Legal title is not black and white when it comes to tax law as you have stated.  There are loads of examples of this. 

There are also numerous circumstances where the person/entity on legal title of the replacement property acquired does not match the person/entity that was on legal title to the relinquished property, such as fully revocable grantor trusts, single member limited liability companies and Delaware Statutory Trusts (DSTs) that are disregarded entities. 

Please refrain from providing incorrect information and bad advice that will inadvertently mislead other investors.

Bill- the only way my information would mislead anyone is if the information I was given is incorrect.  You see, my 1031 was recent and real, not theory.  My entity was one of those disregarded entities you referred to,  And my information source is my QI, from a 1031 exchange service company, such as your own.  For the purpose of this discussion and the scenario proposed by the poster, it's most likely good info.