1031 question on multi member LLC

8 Replies

I have been pondering this tax question for some time. Maybe you guys can help me out. If you own a property in an LLC and sell the underlying property who gets 1031 tax treatment. Do you have to purchase the new asset in the same LLC or will it flow through to the member.

So if I am member of 123 Main Street LLC which owns a duplex and then sells that duplex. Will the 1031 exchange be done by Myself or by 123 Main Street LLC.

If it's done by 123 Main Street LLC is it a hassle to change the name later if new asset is 321 Broad Street. It can be confusing when someone owns several entities not named after the underlying assets.

What i want to 1031 the proceeds but my partner is comfortable with tax hit or we want to invest in separate properties can I 1031 my half, or dies it have to be 123 Main Street LLC that does the exchange?

@Paul Moore Thanks for the mention.

@Max Kats If the LLC is a single member LLC, disregarded entity then you can sell in the LLC and buy in your name or another single member LLC, disregarded entity. Disregarded entities are viewed as one in the same as yourself so you're considered the same tax paying entity.

If the LLC you mention is a regarded entity (not viewed as the same as yourself), then that entity is the one beginning the Exchange and must finish the Exchange by purchasing the replacement in that LLC.

Please let me know if you have more questions!

@Max Kats , Great question.  The tax payer for the property gets the tax treatment.  The tax return that reports the activity of the property is the tax payer for the property and it is on that tax return that the 1031 is reported.  The IRS wants to see the activity of the new property reported on the same tax return as the old property was.

So the key is to follow the tax return it's relatively easy see how the 1031 must be handled. Which is why if you have the property in an LLC that doesn't file it's own tax return it is a disregarded entity and you look for the tax return where the activity of the property is reported.

You mention "partner". If that partner is a member of the lLC then that LLC files a tax return so the LLC will do the 1031 exchange and receive the 1031 benefit.

If the two members are wanting to separate then there are two options:

1. You can have the LLC complete the exchange by purchasing two properties (one for each of you). After the exchange is complete then you dissolve the LLC and distribute the properties to the former members. This dissolution and distribution should not trigger a tax. Yet all of the deferred tax is maintained in the properties.

2. You can dissolve the LLC prior to the sale and distribute the property to each of you as tenants in common. Then sell the property and each of you could do your own 1031 exchange on your % of the property.

The former has been considered to be safer in the past.  The IRS was thought to not be so fond of the second path.  However, there's some recent cases that have made number 2 seem a little safer.  

Either way can work.  Your accountant will probably have a preference.

@Dave Foster

Thank you so much for the two options. I prefer the first one as I'm risk averse when dealing with IRS. In the scenario when the LLC acquires two new properties:

Can the member then distribute directly to a new LLC or would they first have it distributed to themselves individually and then transfer to an LLC?

How do partners in multiple deals 1031 up?

Assume I am a member in 5 LLC's and we liquidate all 5 underlying assets. Would the 5 LLC's be the purchaser of the larger asset or would the only way to achieve this in my situation be option 2 and sell the assets as an individual?

I know it seems specific but I imagine real estate investors run into this issue all the time.

I own multiple properties in individual LLC's with various partners. Is my structure sound or is there a better way to structure it for future 1031 treatment.

I plan to hold but thinking of an exit strategy and also if a bigger deal comes up to step up the basis.

@Max Kats Never fear.  Just when any investor thinks they seen it all.... :)

Each property is it's own 1031 opportunity. It doesn't matter who the tax payer is each one is an opportunity to do a 1031 on the sale. In your example if you and your partner have 5 regarded LLCs (the LLC is taxed as a partnership and files its own tax return) then you'd have 5 opportunities for the LLC to sell the property and purchase multiple replacement properties. Yes, in your first scenario the LLC would be the seller and purchaser.

You can adjust your LLC agreements to reflect whatever you and your accountant want regarding disposition. The key is that the properties that will end up being distributed from the LLCs to the individuals need to closely follow the % membership of each member to make the distributions equitable. But this does leave some room for one member to still use the LLC's 1031 to purchase a larger asset.

Say the LLC is owned by you and your partner as 50% members and the sales price of the property is $500K. That would mean that the LLC could purchase two $250K properties and then dissolve and distribute one to each of you. But you could also have the LLC purchase one $250K property for cash and one for $500K with 50% financing. When the LLC dissolved you would get the larger property but have to assume the debt. That would still make the %s work out.

Whether your LLC structure is sound or not is dependent on lots of variables. I see a lot asset protection built in there. But also multiple tax filings and the cumbersome nature of moving into and out or relationships with your partners.

Strictly from the 1031 perspective tenants in common is the easiest way to own and move real estate.  When each of you are tenants in common you can separate easily at the sale and each of you do your own 1031 or one can and one can take cash.  Just like in the second scenario we talked about.

So in some ways the second scenario might be a better fit for you.  But you want your accountant to weigh in with what they prefer.  There's a lot of nuance inside this question.  I sent you a pm to flesh it out a little better.