Can a real estate holding LLC serve as a 1031 exchange?

Question

I am about to establish my LLC for my real estate holding company. I had a potential investor ask me if the LLC could serve as a 1031 exchange as he was about to sell a property but doesn't have another property lined up. He wanted to know if my LLC would qualify as a 1031 exchange so that he would be seen as reinvesting his money and delaying the capital gains he would owe on the property he's selling. Does anyone know if my LLC would qualify?

Natalie Kolodij · Answer

The issue is selling proceeds from a property and investing in an ownership in an LLC does not qualify.

However- there could potentially be a way to structure this. The 1031 essentially needs the same person who does the exchange and purchases the new property.

He could sell his property, 1031 into a new property. And then there could be some type of JV agreement to add you to the new property, or add you to the property via an LLC down the road.

@Dave Foster is the expert to talk to about this.

Chris Brown · Answer

For an exchange to be valid, exchangers need to trade real property (title / deed) for real property (title / deed).  Exchanging for membership interests in an LLC, which is what the sounds like, will not qualify for 1031 exchange.

Account Closed · Answer

This is a common question, but specifically for a 1031 exchange, there needs to be a sale of investment real estate followed by a purchase of investment property. It is the trade of real properties that are the same in nature or character, even if they have different qualities - two lots of the same approximate size, value, and location could be exchanged.

Bernard Reisz · Answer

@Natalie Kolodij Ownership changes on a replacement property subsequent to an exchange must be carefully navigated, as it can be asserted that the property was not held for investment at the the time of the exchange, but rather for resale.

Michael Skoczylas · Answer

It seems your plan is to BRRR- if that is the plan then creating a DST won't work. The refinancing will likely trip you up, and as Dave mentioned for one investor- the costs and limitations on the business would not justify it. The TIC structure as I mentioned above and Dave did as well will likely be your best and maybe only option.

Josh Acuff · Answer

@Dave Foster Thanks so much for your response Dave. Super helpful!

Dave Foster · Answer

@Josh Acuff, We're dealing with this almost on a daily basis.  Lots of 1031 folks wanting to move into passive mode.  The answers above are correct.  You must exchange into a deeded ownership of real estate (or membership in a Delaware statutory trust because it's been specifically blessed by the IRS).

In your case there's a couple options.

1. If you see this with the potential of a business model involving raising money from multiple 1031 investors you could look at structuring a DST.  I'm not sure the cost would justify setting up the structure for one individual.  But it's an option.

2. If financing allows they could 1031 into a tenant in common interest in the property with their 1031.  This works with 1031 since they're taking a deeded interest in the replacement real estate.  Once the 1031 is complete each tic member could then contribute their % into a new entity which then carries forward the project.  Or you could complete the project as tenants in common and when'/if you sell each of you would have the option of moving forward together or you could each take your TIC interest and 1031 into something else apart from each other.  Doing this on one next month for a client who had a friend locate an excellent property and wanted to partner on it.

Josh Acuff · Answer

Chris and Matthew, thanks for your replies. It seems that you both understand the question correctly. My investor would be selling a property and then would place the proceeds of that sale under my LLCs custody to BRRRR invest into a real property.

From the sound of things, that does not qualify as a 1031 exchange. Even if we are able to demostrate exactly what property his funds went into purchasing? Thanks to you both for your responses!

Michael Skoczylas · Answer

1031 is limited to investments in Real Property. If I understand you correctly, and please clarify if I do not- your investors intent is to invest in an LLC which will be owned by both of you which will hold Real Estate. IF that is the case then the LLC cannot serve as Replacement Property for a 1031. If he intends to exchange into your LLC which holds Real Property, and subsequently he will be the sole owner of the LLC then it would be a good exchange. There are possible ways to have him invest with you using 1031 exchange funds- including TIC (tenant in common) interests.

However, as I understand your question, his 1031 funds would not be able to be used to buy into an LLC owned by the two of you.

Sorry!

Can a real estate holding LLC serve as a 1031 exchange?

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