1031 exchange when Title and Taxes structure differ

[David Shaw]

Hi BP team, Happy New Year!

My brother and I own a 4-unit rental property in Los Angeles, CA, we've owned it for almost 10 years. The property Title is owned 50% by each of us individually, as tenants in common. HOWEVER our taxes for the rental property are filed under a Partnership, each of us owning 50% of the Partnership, then we each get a k1 and file our own taxes etc.. The Mortgage is also under both of our names as individuals, not under the Partnership.

We were interested in selling the property and performing a 1031 exchange, however there is some concern about any issues we would have in the eyes of the IRS with 1031 rules given the way the Title is vs how the Taxes are filed.

The tax filing was setup this way at the advisement of our CPA, however he apparently meant that the property Title should also be changed to be put under the Partnership, there was obviously a miscommunication here.

Would we still be able to perform a 1031, if so can the replacement property Title be structured the same way as we have it now (under each of us as 50% individuals, tenants in common), new mortgage under both our names, and just keep the Partnership for tax filing as it always has been?

1) We would like to avoid triggering any audits due to the Title vs Tax Filing differences.

2) We would like to make sure the 1031 is valid in case of an audit, given the Title vs Tax Filing differences.

Thank you in advance

[Dave Foster]

@David Shaw, It's perfectly fine to do a 1031 on this property.  That's not an issue.  It's just how and who is doing the exchange.

I gotta disagree with @Melanie P. on this one. The deed may be in your names as tenants in common. But the IRS has no clue who is on the deed. They look at the tax returns that report the activity of the property. and right now the LLC is the tax payer for the property because it is the entity that reports the activity of the property on it's tax return.

This means that if you want to really be safe with your 1031 I would not separate interests. The LLC will need to sell and the LLC will need to buy to complete your exchange. This follows the tax returns and is most consistent. The problem will be that the QI for your 1031 will need to use deeding to start your exchange. which means that you wwould be the exchangers even though the LLC is the tax payer. So the safest thing to do is to quit claim the property into the LLC before you sell it. this matches deeding and tax returns. The IRS doesn't even know anything happened because they don't see deeds and the tax returns stay consistent.

Now, there is an option that would accomplish what Melanie is suggesting. And that is to dissolve the LLC before the sale. Doing this now makes you the tax payers because the property will be reported on your individual tax returns. And it's already deeded to you. So you then sell as yourselves and buy as yourselves. And this matches the deeding and tax return also. The only issue with this is that it requires the dissolution of the LLC. Which, while perfectly fine, does show the change to the IRS.

You will want to match the deed in order to do your exchange.  And it's very simple to do so.  The question is do you change the tax return to match the deed?  Or do you change the deed to match the tax return?