Moving 1031 DST property into irrevocable trust? look-back?

Question

Hello 1031 experts, my father has a DST investment previously purchased via a 1031 exchange. He would like to move this investment into an irrevocable trust for estate planning purposes. Would this trigger capital gains? The transfer would be less than 2 years after the 1031 exchange and a broker had told us that there is a 2 year look-back and so the DST investment can't be changed (not sold) to another owner within 2 years without invalidating the original 1031. Others have said that the only look-back to worry about is if the original 1031 exchange was between related parties (it wasn't). Does anyone have any advice here? A) is there any concern moving a 1031 DST ownership into an irrevocable trust within 2 years? and B) are there any other 1031 concerns we should be aware of moving this into an irrevocable trust? Thanks for your help!

Aaron E. · Answer

@Bill Exeter, thanks for your response.

Bill Exeter · Answer

Hi @Aaron E.,

You have to be careful here.

The issue is whether the taxpayer (your father) had the intent to acquire the replacement property as part of his 1031 Exchange and hold it for rental, investment or business use purposes.  The code, regulations and rulings do not have any specific holding period.  The two (2) years mentioned above is merely their opinion or what they have heard, but nothing more.  The key is that you would need to demonstrate to an auditor that your father had the intent to hold should he be audited.

Contributing the DST into an irrevocable trust (separate, different taxpayer from your father) changes the ownership such that they could challenge the intent to hold.  They could argue that your father never had the intent to hold for rental, investment or business use.

There are a few court cases that have been commonly cited to support contributing the property into a separate, different, and distinct entity after the 1031 Exchange has been completed.  However, at least two of them were ruled upon in the 9th circuit court of appeals under the OLD California Partnership Act, so there is no guarantee that the courts would rule the same under the NEW California Partnership Act that is in effect today (or any other jurisdiction).

You should have your legal and/or tax advisors review the proposed transaction to determine what the risks to you might be and then decide whether to move forward.  Remember, the longer the holding period the easier it is to prove that you had the intent to hold for rental or investmetn purposes.

Dave Foster · Answer

Changing tax paying entity prior to a sale and commencement of a 1031 has consistently been challenged by the IRS.  Contributions into new entities after completion of a 1031 is a fairly common practice in the world of partnerships and mergers.

Coordinate with your accountant to ensure that no accidental gain is recognized.

Aaron E. · Answer

@Dave Foster, thanks for your reply. So, as far as you know, there should be no issue in doing the 1031 exchange today and then moving the new DST investment property into an irrevocable trust (with potentially different taxpayer ID as current owner) within a few months? Thanks again.

Dave Foster · Answer

@Aaron E., There's no statutory look back.