1031 Exchange from residential to commercial/residential

[Camy Kwok]

I have lots of questions that hopefully I can get some guidance on!

My mother has a rental property she has held for about 15 years in Washington state and has rented it out for the first 12 of those years. Because the condition of the building has deteriorated requiring substantial renovation she decided to stop renting it out after the last tenant moved 2-3 years ago. We have developers interested in buying the property for about 6 million. With that money we would like to do a 1031 exchange to continue growing her portfolio. Should she do that under a LLC or a trust if she intends to pass those properties to my sister and I should something happen to her? If we have multiple properties, do the properties need to be held under separate LLCs or can they be under 1 LLC? Can she hold properties in both Nevada and Washington state?

My sister and I have a business that we are looking to expand into another location. Could my mother exchange for a commercial property and we pay rent to her? Can we rent a residential property from her? We will of course pay fair market rates.

Thank you!

[Dave Foster]

@Camy Kwok, When using a 1031 exchange the taxpayer for the old property has to be the same as the tax payer for the new property.  So it is important to match the "owner/taxpayer".  But any tax paying entity can do a 1031 exchange. So I would not recommend that she go out of her way now to change the ownership from what it is.

She can use the 1031 exchange to move from any type of investment real estate to any other type of investment real estate anywhere in the country.  So yes, she could do the 1031 exchange and buy commercial property somewhere else in the country for you to expand your business into.  I would recommend that you lease it from her at market rates in an arms length fashion.  If she wants to gift that back to you using annual gift limits that is fine.  But make the lease arms length.

And if liability protection is an issue then she could sell as herself and buy as a "disregarded entity" LLC. An LLC that has only one member and does not file it's own tax return. That may make inheritance a little easier. But if she holds on to the properties until death the heirs will still inherit at a stepped up basis - in other words any deferred tax goes away with her death.

I'll reach out via pm and colleague request to give you more information