Can Multifamily Syndication Deal Do 1031 Exchange?

Question

Hi,

I have invested in a multifamily apartment complex syndication deal.  The Sponsors said when the Company (LLC) sells the property in 5 years, they would try to do a 1031 exchange and roll the proceeds of the sale into another deal.  Is this possible?  If yes, I would like to know how that can be done?  The LLC that owns the current property will buy a "like kind" multifamily apartment - just like a single family house would?

Has anyone successfully done it?

Thanks!

Dave Foster · Answer

@Lue C., Any tax paying entity can perform a 1031 exchange.  In this case the tax payer for the MF apt. Complex can sell that complex in 5 years and do a 1031 exchange.  The LLC will also have to be the purchaser of the new property.  If you are an investor in the syndicate you are probably being given a membership interest in the LLC.  As such you do not own the real estate you own the LLC.  So you cannot do your own 1031 on your %.  The LLC will do the 1031 and you will go forward with the LLC.

Note that the LLC is not restricted to purchasing another apt. complex to complete their exchange.  It may replace the complex with any other type of investment real estate.  Or it may choose to not complete a 1031.  In that case, once again you cannot do your own 1031.  You are stuck with the decision of the LLC in total.

This type of scenario is common and doable.  But you must understand the limitations on your options going into it.  Since you are purchasing membership interests in an entity and not real estate you do not have the opportunity to separate from the entity with your own 1031 as you would with a tenant in common interest.

Brian Adams · Answer

@Lue C., as @Dave Foster stated, Partnership and LLC interests are specifically excluded from 1031 Exchange treatment under Section 1031 of the Internal Revenue Code.

Reason - Partnership interests are personal property, and are not considered to be like kind to the acquisition of real estate, even though the underlying assets held within the partnership are in fact real property.

Dave Foster · Answer

@Jason Ling, That particular strategy has been attacked by the Service and several state taxing boards extensively - California especially for quite a long time.  Florida of course doesn't care.  But that strategy is extremely dangerous.

The "drop" creates a scenario where the individual investors put themselves into "intent" jeopardy first of all.  They took title to sell the property not to hold the property.  Secondly, the transactions are stepped to avoid a recognized gain by the taxpayer (the LP).

As the tax payer for the entity the LP will need to do the exchange.  At the end of the exchange there are some things that can be done to buy individual investors out and even without tax consequences.   But it is very difficult.  I think that's one of the things @David Thompson has been working on lately.

Jason Ling · Answer

In Joe Fairless's interview with a 1031 exchange expert here it seems like you can 1031 out of an LLC that holds a property.

He suggests that it is possible to do a 'drop and swap' where the LLC becomes a TIC with all of the LLC limited partners..

Thus allowing each individual partner to either 1031 or cash-out.

Is this not true?

Taylor L. · Answer

@Lue C. Joe Fairless and his guest discussed this on his episode 995 of the Best Real Estate Investing Advice Ever Podcast, Link to the episode here

Dave Foster · Answer

@Lue C. that's correct.  Your K1 should reflect the non-recognition of gain from 1031 the LLC did.

Lue C. · Answer

@Dave Foster, @Brian Adams  Thank you for your responses!  I think I get it now - I own a share of the LLC, which owns a property.  So the LLC can 1031 exchange to another property, and as a member of LLC, I will continue to be an investor of the new property.  Essentially, I, the investor will not see my share of the proceeds from the sales because it rolls into the the new deal as my seed money.  Am I understanding it right?

Personally, I won't pay any capital gain tax on the proceeds from the sale, because I've never received the "cash/distribution" of the sale?

Nick B. · Answer

@Lue C.,

Yes, 1031 is possible with a syndicated deal if the same LLC that sells a current investment buys another one as a part of the exchange procedure. However, unless all LLC members want to do 1031, the whole process may become very complex.

Here is more information on the subject:

https://www.accruit.com/1031-news/1031-drop-and-sw...

DISCLAIMER: I am not a lawyer or a CPA and this is not a legal or tax advise. Please engage appropriate professionals for better understanding of the 1031 process.

Nick

Can Multifamily Syndication Deal Do 1031 Exchange?

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