1031 Legal/Tax Question

[Eric Dacierno]

My family and I own a vacation rental in Texas worth $400K. Its held in an LLC (Mom 50%/Brother 30%/Sister 10% and Myself 10%). We all live in California and would like to buy a vacation rental closer so we can use it more if the opportunity warrants. We want to sell the Texas condo and do a 1031 into this new property but we don't want to lose this new condo we like. My mom has the cash to buy the new California property outright now. Can she personally buy the property now and later (a few months) the LLC sells the Texas condo and does a 1031 exchange into this new California property? Essentially my mom would sell this new condo to the LLC (of which she is a 50% owner)? Is this legal and legit?

I hope this makes sense. We are trying to use the proceeds and gains (Texas condo purchased for $180k) to offset the increased cost of this new California rental...

Thanks in advance...

[Dylan Brown]

Couple key issues here and unfortunately they both complicate your situation:

1. First Issue: A 1031 exchange cannot be between related parties, and the fact that your mom would acquire the new property (called the "replacement property" in 1031 terms) outright and then sell it to the LLC that she is also an owner of would disqualify the LLC from being a buyer that qualifies for a 1031 with that property as a replacement. For the property to qualify, your mom, her spouse, parents, grandparents, children, or grandchildren (lineal descendants and ancestors) would need to be less than 50% owner of the purchasing LLC. By your account, it seems like 100% of the LLC's owners would be considered descendants of your mother by the letter of the law, disqualifying the exchange.

2. Second Issue:  Personal use and the overall intended use of the property you are selling (called the "relinquished property" in 1031 terms) can be a significant issue if your intention is to do a 1031 exchange. There is some grey area here and more detail than I can get into in a quick reply, but if either the replacement property or the relinquished property are used for more than 14 days per year as a personal vacation home, there are additional considerations and in some cases a 1031 may be outright prohibited. In general, a 1031 exchange is only applicable for investment properties, and any personal use needs to be ancillary to the investment income it generates from rental income (I’m oversimplifying, but generally if you’re not operating this as a vacation rental and have minimal personal use, the 1031 is often off the table).

Issue 2 requires some serious consideration before you move forward, and even if you feel you have a strong case there, I still think issue 1 is going to be a huge hurdle.

Assuming you overcome the hurdles with the second issue, An alternative strategy to get around the first issue could potentially be using an EAT (exchange accommodation titleholder) instead of your mom taking title to the property. This is a third-party company that (for a fee) will essentially purchase the property on paper and hold it until you sell the TX property and can use the funds from that sale to complete the purchase of the new condo. Your mom would just act as the lender to the EAT in this scenario and would get paid back from the TX property sale like any other lender would. To keep it above board, she would just need to receive some interest (minimum legal interest rate right now is ~4-5% depending on the context).

This is obviously all high-level, so it’s important to get into the weeds with your CPA. If your current tax accountant is out of their element with this stuff, be sure to reach out to folks found here in the forums for a second opinion. Good luck!