1031 Exchange from Residential to Commerical

6 Replies

Curious about a particular 1031 caveat as it applies to me... I sold a single family rental with loan and title in my personal name. I put my gains into a 1031 exchange account. Now I want to purchase a multifamily property (5+ units) with a commerical loan. 1031 exchange law requires that exchanged properties must be held by the “same taxpayer”. Meaning that the multifamily must go into my personal name. If I quitclaim the property to the LLC after closing escrow on a commercial loan, I have heard such action could trigger a “due on sale” clause whereby my total loan amount could become due and/or I could be required to pay a prepayment penalty. Without the LLC, my tax structure is less favorable and I am exposed to personal liability. Any guidance on this situation?

You need to check with your 1031 company that did the exchange. When you said (put your gains) you did not get a check or touch the money at any point right and then put in an account?

You are supposed to get the 1031 exchange company in place before you close on the sale of your property and not touch the money.

No legal advice given.

@Nick R.

Ask your CPA and 1031 intermediary but as a single member entity/LLC it can be a "disregarded" entity thus having the best of both worlds.

If not, I don’t think the “due on sale clause” will be invoked based on my experience. 

@Nick R. , When you say 1031 exchange account? Is that your personal account? 

The proceeds from the sale of the original property must be held by a qualified intermediary escrow agent (the proceeds may not be received by the property owner wishing to engage in the 1031 exchange).

Concerning you transfer of the property to LLC, the IRS stated that an individual transferring replacement properties to a limited liability company (LLC) treated as a disregarded entity (i.e., SMLLC) does not violate the Section 1031(a)(1) requirement that the property be used in a trade or business or held for investment.

So if your LLC is single member LLC, you can transfer( after you sort out Due on sale clause with your lender)

Most lenders use boiler plate documents for their loans. You can ask to see their standard forms ahead of time for review.

The due on sales clause thing is in most residential lenders investor loans. You move to commercial and it is generally acceptable to have in LLC's. The lender might narrow down the language more under what conditions you could transfer or change title. That is where if you do not like the way some language reads then your attorney gets involved. The standard bank lender legal fees for their commercial attorney that might be 3,000 to 5,000 can go up. The reason is now they are negotiating back and forth with your attorney to change the boilerplate documents and find a happy medium. So buyers usually want to only go this route if the item is really important. Sometimes the language will say for estate planning purposes only or that the borrower has to maintain a certain ownership interest percentage at all times.

Joel Owens, et al

Thanks for the feedback.  Yes my gains are currently held with a QI, so no worries there.  My imagination started running wild over weekend when my QI office is closed so I reached out to the BP community to help calm my nerves.  Knowledge is calming.

To Carl & Ashish's point regarding the SMLLC, the relinquished property was held in me & my wife's name. We file jointly, if that matters. Can that structure be converted to an LLC?

My identification date is Nov 9th, but nothing has been formally identified yet.  

Thanks

Nick

@Nick R. Hopefully you've heard this from your QI but you and your wife are the same tax payer.  It is actually your return that is is the tax payer for the old property and it is that tax return that must be the tax payer for the new property.  What @Ashish Acharya nailed as the issue is that the contribution of that property after the exchange into a disregarded LLC (one member - your tax return and doesn't file it's own tax return) is perfectly fine.

You lender needs to be asked ahead of time. Especially with commercial loans there is generally not a lot of heart ache about allowing you to contribute into an LLC.