1031 and buying property for small business

Buying & Selling Real Estate
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1031 and buying property for small business

Brian Leong
Member since 2021 · 4 posts · 2 votes

Hi all, 

Long time lurker and first time poster. If this isn't the right place, feel free to move it.

I purchased a rental property many years ago and have been filing taxes under my personal income since I never put it into a LLC. I also have a small business that I run, which is a single member LLC. I'm considering selling my rental property to buy property for my small business to operate out of and utilize a 1031. I have a few questions:

First question, is this allowed?

Second question, if I do this, should I form a LLC for the new property to rent to my business or can I just use the property for my business as is?

Third question, if I don't form a LLC, tax filing wise, would I include the write offs for the property under my individual income, or as part of my small business?

sorry if this has been answered before. I've been searching for a while and couldn't find anything.

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Dave FosterBusiness Member
Qualified Intermediary for 1031 Exchanges · St. Petersburg, FL · Member since 2013 · 9k+ posts · 9k+ votes
5y

@Brian Leong, That is actually a great use of the 1031.  Property that qualifies is any investment property you intend to use productively for investment.  A property housing your business would be perfectly fine.

The question of ownership might not be such an issue. The property is in your name and reported on your personal return. That makes you the tax payer for the property. And your business is a SMLLC. If that LLC has chosen to be taxed as a sole proprietor then it too is reported on your personal return - schedule C probably. That again makes you the tax payer for the business. Or really what is happening is that your tax return is the tax payer for both the LLC and the property.

In a 1031 the taxpayer for the old property must be the same as the taxpayer for the new property. So selling as yourself and buying as that LLC or yourself would be permissable as the LLC is a disregarded entity. Much is going to depend on what your accountant prefers as to the other tax impacts of owning in your LLC.

But either way works if that LLC is disregarded. You can own it as yourself and simply let the LLC use it. Or the LLC can own it. If the LLC is a regarded entity then you would have to take title to the new property in your name. But that then leaves open a bunch of options on how you treat it relationally with your LLC - whether you rent it to the LLC or what have you.

And

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  • Dave FosterBusiness Member
    Qualified Intermediary for 1031 Exchanges · St. Petersburg, FL · Member since 2013 · 9k+ posts · 9k+ votes
    5y

    @Brian Leong, That is actually a great use of the 1031.  Property that qualifies is any investment property you intend to use productively for investment.  A property housing your business would be perfectly fine.

    The question of ownership might not be such an issue. The property is in your name and reported on your personal return. That makes you the tax payer for the property. And your business is a SMLLC. If that LLC has chosen to be taxed as a sole proprietor then it too is reported on your personal return - schedule C probably. That again makes you the tax payer for the business. Or really what is happening is that your tax return is the tax payer for both the LLC and the property.

    In a 1031 the taxpayer for the old property must be the same as the taxpayer for the new property. So selling as yourself and buying as that LLC or yourself would be permissable as the LLC is a disregarded entity. Much is going to depend on what your accountant prefers as to the other tax impacts of owning in your LLC.

    But either way works if that LLC is disregarded. You can own it as yourself and simply let the LLC use it. Or the LLC can own it. If the LLC is a regarded entity then you would have to take title to the new property in your name. But that then leaves open a bunch of options on how you treat it relationally with your LLC - whether you rent it to the LLC or what have you.

    And

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  • Brian Leong
    OP
    Member since 2021 · 4 posts · 2 votes
    5y

    Dave, thank you for such a detailed response. One thing that I was considering was liability of the small business and protecting the property. My small business is sole proprietor so it is a disregarded entity. For tax purposes if I report the property under my small business, would that put my property at risk if there is a lawsuit or bankruptcy in that small business? Right now since it is outside of the LLC, it is protected.

    Also on my tax returns, is it kosher for me to treat it as rental property and then charge rent to my small business and then claim the rent as part of my small business P&L? Or does the IRS prefer to see it differently? Or is there a more optimal method that is recommended?

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  • Dave FosterBusiness Member
    Qualified Intermediary for 1031 Exchanges · St. Petersburg, FL · Member since 2013 · 9k+ posts · 9k+ votes
    5y

    @Brian Leong, those questions are really just going to be your accountants preference.  Since all the entities are disregarded they're all being reported on your personal tax return.  So you accountant is just going to have a preference on which part they place them.  

    And again, since everything is disregarded using the property by your business or renting the property to your business is just going to be an accountant preference.  from the 1031 perspective it really doesn't matter.  I can see some liability protection (or at least anonymity protection) in having the company rent the property. That will generate Sched E income and Sched C expense.  

    The unique structure of your return will determine which is best.  

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  • Brian Leong
    OP
    Member since 2021 · 4 posts · 2 votes
    5y

    Hi Dave,

    Follow up question. Does it matter if the replacement property is a single family home that the business will use as the office? Or does it need to be zoned as commercial?

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  • Dave FosterBusiness Member
    Qualified Intermediary for 1031 Exchanges · St. Petersburg, FL · Member since 2013 · 9k+ posts · 9k+ votes
    5y

    @Brian Leong, Any type of investment real estate can be exchanged for any other type of investment real estate that you intend to hold for productive investment use.  Residential, commercial, industrial, land all can be interchanged and used for investment.

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  • Bonnie Griffin KaakePro Member
    Real Estate Consultant · Denver, CO · Member since 2021 · 661 posts · 389 votes
    5y

    @Brian Leong 

    You have been given some great advice from @Dave Foster. When you make that 1031 exchange into a building that you will be using for your business, be sure your CPA/tax professional groups your business with the building. This must be done in the first year of ownership and will make your property "active" so that you can use any paper losses generated by doing cost segregation, against your business income. If this is not done, the building is a passive investment and losses can only be used against what you are paying in rent to yourself. 

    [email protected]303-475-4459
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  • Brian Leong
    OP
    Member since 2021 · 4 posts · 2 votes
    5y
    Originally posted by @Bonnie Griffin Kaake:

    @Brian Leong 

    You have been given some great advice from @Dave Foster. When you make that 1031 exchange into a building that you will be using for your business, be sure your CPA/tax professional groups your business with the building. This must be done in the first year of ownership and will make your property "active" so that you can use any paper losses generated by doing cost segregation, against your business income. If this is not done, the building is a passive investment and losses can only be used against what you are paying in rent to yourself. 

    Hi Bonnie,

    Thanks for that information! One question regarding that. If I group the property with my small business, won't that put my property at risk if my company ever gets sued or goes bankrupt? If so, is there another way of structuring this so that I can keep the protection but reap the benefits of being active?

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  • Bonnie Griffin KaakePro Member
    Real Estate Consultant · Denver, CO · Member since 2021 · 661 posts · 389 votes
    5y

    @Brian Leong That is an excellent question! I am not an attorney or a CPA, nevertheless, I have clients that have their business in one business entity and put the building in another entity. This gives them an added layer of protection. Grouping still works as long as the ownership of the business and the building are the same person(s). 

    [email protected]303-475-4459
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