1031 Exchange from Personal to LLC

7 Replies

Hi,

My wife and I had a rental property in our names and after making capital gains have decided to sell the property and perform a 1031-Exchange. We have identified a small apartment building as a like-kind asset and currently have it under contract. Given the increased scale of this new asset we are interested in creating an LLC to limit our liability. I am unable to get a clear answer if I can do the like-kind exchange from our name to an LLC where we are the entity owners. Any advice would be greatly appreciated.

Thanks in advance,

James

@James Hentz , It can get murky but the key is that the tax payer for the old property has to be the taxpayer for the new property.  But who is the taxpayer???  It's not necessarily who is on the deed.  The taxpayer for a property is the tax return on which the property is reported.  If you and your wife file a joint return then that return is the taxpayer for that property.

Which means that your personal return also has to be the tax payer for the new property. If you form an LLC that has a single member and elects to be taxed as a sole proprietor and does not file it's own tax return then even if the property is deeded to that LLC it does not change the tax payer. All activity of the property is reported on your schedule E as always. So technically you could make this kind of election.

However, if the LLC has more than one member or is still a single member but elects to be taxed as a partnership then that LLC will file it's own tax return. You will have a K1 partnership return to report on your tax return. But the LLC is now the taxpayer for the property. So you have changed tax payers. And that is not allowed.

I would always recommend that you make the deeds match as closely as possible as that avoids questions or an argument with an inexperienced field agent. If you want to go that route then you could simply sell as yourselves, do the 1031 and buy as yourselves and then after the fact quit claim it into the new LLC. That works as well.

I've got a video training on that subject I can forward to you.

@Dave Foster gave a great explanation. In the simplest terms, the entity, whether a person or corporation, that sold the old property has to be the same entity that buys the new property. I would do what Dave recommends and purchase the new property in your own names and quit claim it to your LLC. Much easier that way.

@James Hentz Yes, you can. The basic requirement of the like-kind exchange is that the taxpayer of the relinquished and replacement properties needs to be the same person. In this case, you and your wife are taxpayers. Since the relinquished and replacement properties have your names 'owners', doing a 1031 exchange shouldn't be a problem. Once you've acquired the replacement property, change it to a LLC. Your 1031 exchange will remain valid.

hi @Dave Foster thanks for the explanation! i have a similar situation where i have a SFH that I plan to 1031 into a multifamily. my current lender doesn't allow for the SFH to be changed to an LLC. if i do the exchange in my name and the new lender also doesn't allow the change to an LLC, are there other ways i can consider in protecting my asset?

@Anne Whalen , There's a couple of suggestions I can think of.  Some would say to go ahead and make the transfer because the bank will never care as long as payments are made.  I would never counsel that.  It's a form of mortgage that could bite you very hard in bad situation.   Don't take money if you're not going to honor the banks terms.

But that being said here's a couple suggestions. First make sure you've talked to several lenders. You're probably going for a conforming loan from a non-portfolio lender. They have to meet certain guidelines in order to be able to sell their loans and ability to easily foreclose is one of those types of guidelines. There are actually many investment lenders who require just the opposite - that you take title in an LLC to avoid homestead complications in a potential foreclosure.

Second you can many times get as much liability protection from an umbrella home owners insurance policy or private liability policy as you can from any asset protection entity.  I've kept several vacation rentals with boats in my personal name for financing purposes but kept an umbrella policy that gave us everything we needed.   

You can also separate some risk by setting up a management company as an LLC and have all activity of the property in your name be contracted to that entity. So any missteps in management will fall to that LLC and not you personally. How effective this is is up for debate. But I have clients who have gone this route.

l

@Dave Foster

Thank you! Have you had any clients who used a 1031 for a property owned by a Real Estate Privacy Trust? I heard of some owners transferring personal property into a trust with the profits controlled by an LLC. If that were the case, the owner paying the taxes should be the same for the transaction and the management would be done through the LLc, similar to the scenario you mentioned above, right?

@Anne Whalen Similar yes although I don't have direct experience with that particular vehicle.  The key is to look at what tax return is reporting the activity of the property.  That tax return is the tax payer for the property.  That tax return is who must be the seller and buyer in the 1031.  Any tax paying entity can do a 1031 exchange.

What makes it work in your case (financing issues aside) is that a single member LLC that chooses to be taxed as a sole proprietor does not file its own tax return. All activity of the property is reported on your personal return. That makes the LLC a "disregarded entity" and you the real taxpayer.

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