What State Should I Create My LLC?

Question

I will be completing a 1031 exchange in the next couple of months. Selling prop in Washington and buying in Montana. My current property is titled to my wife and me as a married couple. We want to title the new prop in an LLC. Since I live in WA but the new prop is in MT, what state should I file/create my LLC?

Bill Exeter · Answer

Hi @Jeremy Schneider,

The key from a 1031 Exchange perspective is that the "taxpayer" has to be considered the same "taxpayer" on both sides of the 1031 Exchange transaction.  You and your wife are the "taxpayer" on the relinquished property, so you and your wife would also need to be the "taxpayer" on the replacement property sides.

Using a new limited liability company to acquire and hold legal title to the new replacement property will work as long as it is considered a single member limited liability company and a disregarded entity.  A disregarded entity is ignored for tax purposes and treated as if the underlying property is owned by the members.

There is a specific IRS ruling that allows a limited liability company to be treated as a single member LLC and disregarded entity when a husband and wife are the sole members as long as the husband and wife live in a community property state.  Washington is a community property state.

Your CPA and attorney should review your situation to ensure that the new LLC would be considered a disregarded entity for tax purposes.

Dave Foster · Answer

@Mike S., as long as @Jeremy Schneider and his wife set up a single member LLC that chooses to be taxed as a sole proprietor the activities of the property will still be reported on their personal joint tax return.  In that event the IRS does not perceive that the tax payer has changed.  The tax payer is still them (or more accurately their tax return).  That would allow them to sell as themselves and buy as a "disregarded" LLC.  This is used quite often when crossing state borders in a 1031 as many state require either an LLC in their state or at least an LLC that is domesticated to that state.  Jeremy, you'll want to get some extra eyes on your transaction, especially the transition to a new lLC as WA is still one of the hold out community property states I believe.  And that will have some special considerations.

Jeremy Schneider · Answer

Thanks to all. I've got an appointment with my CPA and attorney next week to make sure all considerations are being made.

Mike S. · Answer

As a general rule you would want the LLC in the same state as the property as you may have to act in court (eviction, code enforcement appeal, tenant lawsuit, ...). If your LLC is not organized or foreign registered in that state, it will not be able to legally act. There are exceptions: For some state like CA where the franchise taxes are prohibitive, you may use some other tools like trusts as an additional layer to circumvent them.

Also you would need to evaluate the LLC asset protection of that specific state. Some states offer almost no outside liability protection, while some offer the charging order as sole remedy, even for single member LLC.

So if the property is in a state where the LLC protections are weak, you may want to have that LLC owned by a holding LLC in WY that will give you that outside liability protection. In addition WY will also give you anonymity.

Last but not least, I am not sure that during a 1031 exchange you are not mandated to have the same ownership for both of the exchanged properties. Is taking the title into a disregarded entity that you own considered the same as your personal ownership of the original property? I don't know and you may want to check with a tax attorney knowledgeable in 1031 exchange.

Maria Bakaj · Answer

I've pondered the same question with out of state investments.  You definitely need to consider potential tax implications on this.  States are different in how they handle income earned out of state.  I'd play it safe and check with an attorney.

What State Should I Create My LLC?

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