Hi all - I have a question that is most likely for tax specialist's and attorneys, but I thought I would see if anyone here has any insight.
I sold a property with a partner and we put the money into a 1031 and bought two additional properties. The 1031 company only transferred my name onto the new properties and not my partner (we should have caught this but we didn't until it was already done). Its basically like she just disappeared off all of the documents. My partner is a good friend of mine and so we just assumed it was fine and that we would work it out through a side contract or something like that (probably not the smartest idea - rookies here). But, now that taxes have come around, because the 1031 was never put in her name, she is getting taxed for the capital gains on her portion, which defeats the whole purpose of the 1031. I have a few questions:
1. Is it possible to have the 1031 exchange company/title company fix this?
2. Will this make the 1031 invalid for me?
3. IF we were able to get her back on the paperwork, would it affect the loan I have?
4. Another option is to buy my partner out if we cannot get her name back on the documents, doing this would I eventually pay capital gains on her original profit from the first sale? even though she is being taxed on it now?
Any insight or pointers in the right direction would be greatly appreciated! Thank you in advance.
@Hailey Brown You should definitely talk to the intermediary who handled the 1031 exchange and find out how to fix the title issue. Your partner's CPA should be able to enter the exchange in their tax program and defer the tax. She would need to discuss the situation with her CPA to find out what documentation they need for their workpapers, which may include a letter from the exchange intermediary stating that they made an error and are in the processing of correcting it. This shouldn't invalidate your 1031. If you personally guaranteed the new loan, then you a probably stuck as guarantor until you refinance it. If you decided to buy her out, then you would count the buyout amount as part of your basis and that would negate any deferred capital gains for you related to her portion.
@Hailey Brown , Your situation is not unfixable because all of this has transpired before your next required tax filing. What is important is that the tax returns reflect everything accurately. So like @Bob Norton says your partner and your cpa need to reflect the substance of the transaction. And then figure out what the heck happened while the QI was managing your 1031.
But It's not as simple as them simply forgetting to put her on title. There is an entire chain of documents all needed to reflect you and your partner selling the property and performing the 1031 as tenants in common, performing the 1031 together and then purchasing the new property the same way.
First the exchange agreement you signed with them should have reflected both you entering the 1031. The settlement statement was obviously signed off on by both of you. And the settlement statement should have reflected the entirety of the proceeds going to the intermediary. So your 1031 should have started off documented correctly (we hope). The fact that it didn't end correctly is a mystery. The lender should have picked up on it when sourcing funds. the QI absolutely should have caught that. You should have caught it because the QI should have hammered in the point to you. And of course the title company should have made the closing statement match the contract. So that's another point where everyone should have seen you and your partner together.
Hopefully the QI did at least some of that. If so then you've got the guts of your 1031 intact. You need to have the title company do a quiet title transfer to title the property together. Make sure the accountants reflect the entire year appropriately and fill out the form 8824 for each of you appropriately. And put your QI on notice to sharpen up.
@Hailey Brown This is very unfortunate- and should not happen. But I think the first question is how the first property was titled - you say she is your "partner" but is it a tax partnership? or were you guys tenants in common? I think that will be the most important question to figure out before you proceed. But once you figure that out- it should be an easy fix. Report on your taxes how you intended to do it and fix it with a quiet title action to you and your partner (or however it was owned).
Good luck- and good catch. While this may be frustrating, it is fixable, and should not ruin your- or her 1031.
@Michael Skoczylas What do you mean by tax partnership? and tenants in common? neither of us ever lived in the property, it was just an investment. I was claiming the rental income on my taxes only.
@Hailey Brown You were reporting all the income? or just 50% of the income? Was it in you individual names?
@Michael Skoczylas I was reporting all of the income. It was in my name and her LLC. I am going through all the documents now to see where her LLC fell off and its kind of hard to tell.
@Hailey Brown , You were reporting all the income and activity of the property on your return but you owned the property as tenants in common with her LLC?? That's going to be problematic. The "tax payer" for a property (the entity that has to do the 1031 exchange) is actually the tax return that reports the activity of the property. The deed usually reflects that but not always. So although the QI and title company should have reflected the purchase identical to the sale, you and your partner may have issues down the road. Her LLC owns a property but that LLC is not the tax payer for the property if all the activity is reported on your personal return.
Good news - the purchase now shows the deed reflecting the actual tax payer - you.
More good news - her LLC really doesn't have to have a taxable event since it was never reporting the property.
Even more good news - You probably don't even have to mess with correcting anything.
Bad news - You've got to figure out how to get her correctly involved as a co-owner of the property going forward.
Get thee to an accountant :)
@Hailey Brown I think you need to look back at the reporting and ownership first. Your attorney and accountant likely have a better picture of this. This can be solved, you just need to figure out what the actual issue is first. Start with where you were- and then you can get to where you want to go.
@Dave Foster @Michael Skoczylas Ok, yes that is what I have figured out from the 1031, I was the only tax payer on the property that we sold, so the exchange is only in my name. Which is all good, except it looks like she just dropped off of everything. Do either of you know how expensive the process is to get her on the new titles?
@Hailey Brown it should only be a filling fee with the County- which varies based on location. It should not be an expensive process at all.
@Michael Skoczylas ok good to know! thank you!
@Hailey Brown , You sure can. The key is when. If you refinance a property right before a sale and 1031 (some would say in the same tax year but there's nothing fixed) the IRS has a nasty tendency to view that as a way to take profit without paying tax. Many such refi first 1031 next exchanges have failed.
However when you first complete your 1031 and then do a refinance afterward (again no fixed time but many see no problem with immediately refinancing) the IRS no longer sees you as taking profit. You are accessing equity through a debt instrument. So no tax is due and it doesn't impact . your completed 1031 at all.
There's no hard and fast rule on the timing. And I have many accountants who feel strongly that if refinancing (think like the brrr strategy) is a regular part of their clients business practice that they can refi prior to a sale at will - as long as they keep a good paper trail that the refi was normal and only went to business practices.
To be safest - Complete your 1031 and then refinance afterward.
@Dave Foster ok great, thank you. It has been about a year and a half since the 1031, so I should be good.
The longest I have seen practitioner's suggest is 18 months. So even by the most conservative estimate you should be fine!
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