Will this void the 1031 exchange??

4 Replies

On a 1031 exchange when an LLC owns the property and one member of the group wants a return of profit and capital, will that void the 1031 exchange tax rules if the member is paid at closing and the proceeds do not go back to the LLC account?

Thanks!

@Lee Schram

It is the LLC that must do the exchange and both sell the old property and buy the new property. In essence what the LLC would doing is a partial exchange. It can be done But here's the first problem: The money that goes to the individual is boot and does create a taxable event. the second problem is that you'll then have the problem of an LLC that has done a 1031 exchange, incurred a recognition of gain event and you have to figure out what to do with the member who got the cash, caused the recognition but is still a member of the LLC so has a membership interest in the property by virtue of his membership interest in the LLC.

If the LLC were to do a complete exchange and then buy out the membership interests of the one party that could be done with your cpa's blessing.

Or another option that our clients have pursued many times in the past has been for the LLC to complete a partial exchange and then after the fact dissolve the LLC and distribute the property to the members who want to go forward and the cash and associated tax liability to the individual wanting to cash out.

I'm not an expert on this topic, but have heard of the situation being dealt w/ on some local apartment LLC's. My understanding is that just before closing, the non-exchanging members' shares were bought out at the sale price, leaving all the remaining members to participate in the 1031 exchange.

@Lee Schram

This is a partnership issue.  Partnership issues are one of the most complicated areas in the 1031 Exchange world. 

The issue is that the LLC has multiple members and is therefore treated as a partnership for income tax purposes. This means that the individual members/partners do not own real estate. They own a partnership interest in the partnership/entity. The partnership actually owns the real estate. The sale of real estate is actually a sale by the partnership and not the individuals, so the partnership is the taxpayer and would structure the 1031 Exchange.

However, there are many times when the partnership no longer wants to stay together and one or more of the partners/members want to leave, cash out and go their separate ways, or each one want to complete their own individual 1031 Exchange rather than exchanging together as a partnership.  Partnership break-ups create very complicated income tax problems when trying to keep each of the partners/members happy and trying to structure 1031 Exchanges.

There are numerous possible solutions, but they depend on many factors, especially what the goals and objectives are for each individual partner/member. In your case, if all of the members want to stay together in the LLC (partnership) except for the one member, then it would be relatively easy to redeem/purchase/buy back the one person's partnership interest so that he/she cashes out at the close of the sale and the rest of the members/partners stay together and continue through a 1031 Exchange at the LLC level.

thanks everyone for the information. 

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