1031 exchange, tenants in common

8 Replies

Have a house closing under a single member LLC selling for $145,500. We will be doing a 1031 exchange and then taking those proceeds and applying them to a vacation rental cabin investment of $264,000. We are getting a 30 year joint mortgage on the cabin and then after it closes, redeed it back to the LLC. The 1031 exchange guy is telling me that we need to devy the shares by tenant in common ownership. He says the contract and deed both need to be written as tenant in common. Question is this. How do you write this up on the contract correctly? Is this really on the contract or is this an agreement done outside of the contract?

You might ask about releasing the acquired property from the LLC as the break in chain of title might be an issue to keep the 1031 in compliance.

I'm not an expert in 1031's it's just something I picked up on reading through your comments.

I believe Christopher is correct....but you really need to talk to an expert. My understanding: title must be held in the exact same manner as the relinquished property. If you change ownership, I suspect your 1031 is abolished.

No company avatar mediumJohn Thedford, John Thedford | 239‑200‑5600 | http://www.capehomebuyers.com | FL Agent # BK3098153

I am looked at as the same person due to single entity so I know I could have it in my LLC or my name, it is the question of % of ownership adding the husband.

You need to have a 1031 handle this as it is complex. Here is an article I ran across on partnerships and LLC's for 1031 exchanges.

No legal advice given.

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Like any taxpayer, a partnership (and a limited liability company taxed as a partnership,

generally referred to herein as a “partnership”) can engage in a like-kind exchange under

IRC Section 1031 to defer paying tax on capital gains. Difficulties can arise, however,

when the individual partners desire different outcomes with regard to the sale of property

by the partnership. Some partners may wish for the partnership to stay together and do an

exchange; others may want to do their own exchange with their portion of the property;

still others may wish to receive cash and simply pay the tax. What alternatives are

available to the partners?

PARTNERS DOING SEPARATE EXCHANGES

A taxpayer must own a capital asset to do a 1031 exchange. The fact that a partnership

owns a capital asset does not mean that the individual partners have an ownership interest

in that asset. The partners merely own partnership interests. Partnership interests are

specifically excluded from Section 1031 under section 1031(a)(2)(D). Therefore, if an

individual partner wants to do a 1031 exchange, the partner must convert his or her

partnership interest into an interest in the capital asset owned by the partnership.

One method for accomplishing this, known as a “drop and swap,” involves the liquidation

of a partnership interest by distributing an interest in the property owned by the

partnership. After completion of the “drop,” the former partner will have converted his or

her partnership interest into an interest in the actual property itself, as a tenant-incommon

with the partnership. The property can then be sold, with the former partner and

the partnership each entitled to do what they wish (sale or exchange) with their respective

interests.

Related to the “drop and swap” is the “swap and drop.” This involves the same two

steps, but in reverse order. The partnership completes the exchange (the “swap”), and

then distributes an interest in the replacement property to the departing partner.

HOLDING PERIOD ISSUES

Both the “drop and swap” and the “swap and drop” alternatives raise potential holding

period issues. If the “drop” occurs close in time to the “swap” (or vice versa), there may

be some question as to whether the relinquished property (or replacement property) was

“held for investment.” Also, if the drop appears too close in time to the swap, the

partner’s exchange may be deemed an exchange by the partnership under the Court

Holding case (See Commissioner v. Court Holding Co., 324 U.S. 331, 65 S.Ct. 707

(1954) . Clearly, the more time that passes between the “drop” and the “swap” (or vice

versa), the better.

Regarding the above issues, a line of federal cases (Bolker, Mason, Maloney, etc.)

provides taxpayer-friendly authority against challenges by the IRS. However, some state

taxing authorities (notably, the California Franchise Tax Board) aggressively challenge

exchanges, and argue that they are not bound by these federal cases. Also, changes made

in 2008 to the federal partnership tax return (IRS Form 1065) make it easier to detect

when drop and swap transactions have occurred, thus making such transactions more

vulnerable to challenge by taxing authorities.

PARTNERS GETTING CASHED OUT

In some instances, a majority of the partners may want the partnership to complete an

exchange, but one or more of the other partners may want to be “cashed out” with the

sale of the relinquished property. One way to accomplish this is for the partnership

simply to receive cash from the sale in an amount sufficient to purchase the departing

partners’ partnership interests. This cash, however, would be “boot,” and would require

the partnership to allocate the resulting gain among all of the partners.

A better alternative, known as a partnership installment note (“PIN”) transaction,

results in the gain associated with the “boot” being recognized only by the departing

partners. In a PIN transaction, instead of receiving cash, the partnership receives an

installment note in the amount necessary to cash out the departing partner(s). The note

is transferred to the departing partner(s) as consideration for their partnership interests.

If at least one payment under the note is to be received in the year following the

exchange, then the gain associated with the note will be taxed under the Section 453

installment method, and recognized only when the actual payments are received by the

departed partner(s).

The PIN transaction is complicated, and should be handled only by a qualified

intermediary experienced in such transactions, such as the affiliate of Asset Preservation,

Inc., Stewart Institutional Exchange Services, LLC ("SIES").

EXCHANGES FOLLOWED BY CONTRIBUTION

When an individual completes an exchange and then immediately contributes the

replacement property to an entity, or when an entity exchanges property immediately

after receiving it as a contribution, a holding period issue could arise. Such an issue was

resolved in the taxpayer’s favor in the Magneson case, which involved an exchange by

an individual, followed immediately by a contribution of the replacement property to a

general partnership. Magneson provides useful authority against challenge by the IRS,

and the same logic was applied at the state level in the Marks in Oregon, although its

application in other states is not clear.

ELECTION UNDER SECTION 761

As stated above, partnership interests are specifically excluded from the application of

Section 1031. A very narrow exception applies to a partnership that has elected, under

Section 761(a), not to be subject to the partnership taxation provisions of Subchapter K.

The election applies only to a partnership: (i) for investment purposes only and not for

the active conduct of business; (ii) where the partners hold title to the property as coowners;

(iii) where each owner reserves the right to separately take or dispose of his or

her share of the property; and (iv) which has no active trade or business. If a partnership

makes such an election, a partnership interest will be treated as an interest in the

underlying assets, and can be exchanged under Section 1031.

PARTNERSHIPS AND 1031 EXCHANGES

“AVAILABLE OPTIONS FOR PARTNERS AND PARTNERSHIPS (AND LLCS)

APIexchange

Medium allworldrealtyJoel Owens, All World Realty | [email protected] | 678‑779‑2798 | http://www.AWcommercial.com | Podcast Guest on Show #47

We are not a partnership. The LLC is a sole proprietor LLC owned by me only. The LLC is looked at as disregarded entity so it is always me as the LLC or myself.

@Gayla Kemp , I can't understand what your intermediary is trying to say. There is no tennant in common possibility with what you are describing. Tennant's in common requires two or more tennants, two or more owners. So maybe I'm missing something. But the asset is owned by an LLC of which you are the only member - that's not a scenario for tennants in common.

The LLC is the sole owner of the property. But where you have the possibility to do something is by virtue of the LLC being a pass through entity. It's easy to see who the true tax payer of the property is. Look at last years tax return. If the LLC filed a return of it's own then the LLC has to do the exchange as the tax payer and it has to sell and purchase. However, my guess is that the property is reported on your tax return Sched E. If so then yes disregard the LLC. You can either do a quiet deed to transfer into your name and then purchase as your name and after the fact (with the mortgagor's permission) re-deed back into the LLC. We have clients go both ways on this with the blessing of their tax and legal counsel. this is not one of the scenarios @Joel Owens is talking about with the discourse on swap n drop or drop n swap.  All the quiet claim is designed to do is to bring in line the tax payer and the name on deed which at this point in time are probably different.

The only thing I hear that is a potential bug in the works is the "we" you refer to. If that is your spouse and you file returns "married filing jointly" then once again regardless who is the member of the LLC, if the property is on that joint return than the two of you are Joint tennant owners of the property and the pass through provisions would still apply.

If the "we"  is friend or some other relationship then be very careful to keep them separate from the property until down the road after the dust settles for a while on your 1031. Unless you are in one of the few community property states or a hybrid thereof, they are not the tax payer for the property.  They are not an owner and cannot be involved in your 1031.

Medium ergDave Foster, Exchange Resource Group | [email protected] | 850.889.1031 | http://www.erg1031.com

Thanks Dave, that is what I was thinking, with joint returns, it should be okay. Yes, it flows down to our married joint filed tax returns on Schedule E. So, if I brought it down to my self and added my husband to close this under a 30 year mortgage, it would still be on the married joint filed tax payer return. We are only bringing it down to joint individuals for the 30 year mortgage purpose and then re deed it right back to the LLC.

1031 guy told me that we need to do tenant in common ownership on the contract and on the deed. Is tenant common ownership really written on these things? I don't recall in the past writing a contract as "joint ownership with survivorship", they were always written in our names only. So, would the tenant in common for the 5-minutes of title be on the contract and deed or just on an agreement? At the end of the closing it will be deeded to the LLC. We live in Oklahoma.

Main reason for asking all of this is that I have already submitted a contract for the replacement property as our individual names only, not adding tenant in common to the seller.

@Gayla Kemp But here's the problem You're not tennants in common. You are one tax payer. It's not common to place a tic % on a contract when the tenants are Joint. Many times we will see JTWROS. But in most states that's now understood anyway. In Oklahoma which is not a community property state there is still the coverture property concept which allocates property acquired during the marriage equally to husband and wife. Once again I can't see where a TIC allocation would be needed to satisfy the 1031. perhaps there's some other legal reason. I would encourage you to press them on that question.

To reduce the ownership down to the filing tax payer is exactly what you want to do. To go through the rigamarole of assigning TIC %s seems to be both unnecessary and dangerous because you are now flirting with a change or perception of change of ownership structure.

Going into contract as your names does not hurt anything. There will be an assignment to the QI on the hud and title will be deeded directly from the LLC to the buyer. On your sale side, it is the same. You will assign the contract rights to the intermediary. Title will go directly to you per your mortgagor and then you will quit claim into the LLC if they allow and you choose.

Medium ergDave Foster, Exchange Resource Group | [email protected] | 850.889.1031 | http://www.erg1031.com

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