LLCs and 1031

[Mackenzie Wallace]

Ok so here is my question...I'm just getting started out in the idea of real estate investment and whatnot. I am only 27, a lawyer and I work a 9-5 that I like. My mother is closer to retirement age and has wanted to design and flip houses her whole life. So we started a little LLC with just the two of us. We want to flip houses, and maybe down the line get into having a few rental properties. Now don't let the fact that I have a legal background deceive anyone...Basic Income Tax was NOT my strong suit and I barely passed the class in law school! So while ultimately we will have the help of a CPA when we file taxes (haven't even purchased our first property yet), I am still trying to get a grasp of capital gains taxes on investment properties, when you can use 1031 form, etc.

Any information pertaining to those issues with regards to an LLC would be so helpful and appreciated!!

Thanks so much! 

[Bill Exeter]

Hi MacKenzie,

Congratulations on joining Bigger Pockets and welcome! 

I will jump in here on the topic of 1031 Exchanges. 

The first requirement in order to qualify for 1031 Exchange treatment is that the properties involved must be held for rental, investment or business use.  Properties that are acquired and held for sale such as rehabs, flips, development, etc., are actually treated as inventory in your real estate business and therefore held for sale (as opposed to investment) and do not qualify for 1031 Exchange treatment.  So, any properties that you and your mother buy to rehab will likely not qualify, but those that you buy, rehab and then actually do hold for rental/investment purposes would qualify. 

The key issue is your intent to hold for rental or investment purposes.  If you do a lot of rehab/flip, you will have to go overboard on those that you hold in order to demonstrate that those specific properties were intended as rental/investment properties.

Finally, the issue of the LLC. Your LLC is a two person LLC and unless you elect otherwise will be treated as a partnership for income tax purposes, so any 1031 Exchange transactions would be structured under the LLC's name as a partnership. If you and your mother ever decided to wind up the LLC and go separate ways, you would need to make some proactive changes to property held for rental/investment purposes in order to qualify for 1031 Exchange treatment.