Title Requirements: 1031 Exchange Series Part Six
Welcome back to our seven-part series on the basic requirements of a 1031 Exchange! In our last article, we discussed the need for the Qualified Intermediary during the exchange. In this, part six, we are going to move on to title requirements. As we’ve now learned, the IRS is very detailed when it comes to the rules and regulations of a 1031 Exchange. Part of those regulations include very specific title and taxpayer requirements. Now we are going to discuss what those requirements are and the best way to avoid any title issues during the exchange.
Title Requirements in a 1031 Exchange
While there might be a lot of complicated statutes to understand during a 1031 Exchange, the title requirements are relatively straightforward. This requirement states that in the same manner the taxpayer holds title to the old property that is how the taxpayer must take title to the new property. Essentially this means that the taxpayer of the old property has to be the taxpayer of the new property. Therefore, if you are the taxpayer for a piece of property and sell it through a 1031 Exchange, then you must also be the buyer of the new property to qualify for the tax deferral.
Any tax paying person or entity that owns real estate is able to do a 1031 Exchange. That means you, as an individual, as well as any corporation, LLC, partnership, or trust could do an exchange. However, that doesn’t mean that an individual can complete a 1031 Exchange on property that is owned by an organization. The basic rule of thumb here is to check the tax returns. The name on the property and tax return will usually match. But the most important consideration is whose tax returns report the activity of the property.
Avoiding Title Requirement Issues
In a 1031 Exchange, title requirements are met when the taxpayer who owned the old property is also the taxpayer on the new property. We have also been asked if people should be added to the title before a sale. The answer to that is no. For example, Sue owns a rental property and she is currently the only one on the title. She may want to add another individual to the title right before she sells it. This is not recommended. By doing this another taxpayer has been added to the property. The IRS could then come around and ask why this person took title to the property. Did they take it to hold it for productive use? Or did they take title to primarily facilitate the sale? These are small details that could jeopardize a 1031 Exchange if they are not sorted out properly.
But this also illustrates another facet of the consistent taxpayer. What if that individual that the person above wanted to add to the deed happened to be her husband? If they file a joint tax return then the IRS actually perceives both of them to be the same taxpayer by virtue of the joint tax return. In that event adding her husband to the deed right before sale does not change the taxpayer and would be permissible.
As we mentioned above, entities such as corporations and an LLC can own real estate. While there are many different people involved in this process, the title requirements state that the taxpayer names must match. Therefore, you as an individual cannot complete a 1031 Exchange with property that is owned by another entity, even if you are a part of that entity. Your best bet is to always check the tax returns to be sure.
Do You Have Questions? We have Answers!
While the title requirements in a 1031 Exchange seem simple enough, we’ve seen clients accidentally trip over this step more than once. Always make sure you check the title and the tax returns to be sure. The taxpayer of the old property has to be the taxpayer of the new property. And it’s not as simple as simply matching the deeds. There are going to also be lending issues and certain state tax issues that can get in the way and trip you up if you don’t have an experienced guide as a QI.
If you have any questions at all about these requirements, contact me and my team at 850-889-1031. We’re here to help with any questions you have regarding your 1031 Exchange.
In the next and last part of our series on the basic requirements of a 1031 Exchange, we will be discussing the reinvestment of cash or the equal or up rule. This is a very important last requirement, so don’t miss out!