1031 Exchange - can I purchase a seller's LLC?

Question

I recently sold a 4 plex that was held in my name and I want to 1031 exchange into a small apartment complex, which I have under contract. The apartment complex is held in an LLC, single member. Rather than purchase the apartment complex outright, I would prefer to purchase the ownership interest in the LLC. Please correct my assumption if this is wrong, but my understanding is that the county tax assessor would see a real estate purchase/sale and would be able to reassess the taxes on it. However, if I purchase the LLC, I am buying a business that includes the real estate and it is less likely that the tax assessor would be aware of the transfer and new sales price.

So I have two questions – is my understanding of this correct? If so, would this kind of transaction qualify for a 1031 exchange? I am not sure if a single member LLC can be purchased or if it is dissolved when sold. Maybe I could create a new LLC and transfer the asset from the LLC I am purchasing into my new LLC at the closing table?

So I have two questions – is my understanding of this correct?  If so, would this kind of transaction qualify for a 1031 exchange?  I am not sure if a single member LLC can be purchased or if it is dissolved when sold.  Maybe I could create a new LLC and transfer the asset from the LLC I am purchasing into my new LLC at the closing table?

Mark Creason · Answer

The reason he wants to buy the LLC outright instead of the actual property is to keep the property tax from re-setting.  In California, thanks to Prop 13, taxes are raised at a yearly maximum of 2%.  If he bought a 500k property, taxes would re-set to the 500k value.  If he could buy the LLC for 500k, and the property was purchased for much less, he would save the difference yearly in property taxes.  I would think the Franchise Tax Board in CA would have issues with that.  Every year, you will file a form for renewal of the LLC.  Eventually they will figure out ownership of the LLC changed.  The FTB is worse than the IRS, so be careful.

Mark

Dave Meyer · Answer

I am absolutely not an expert on this, but just went through something similar. Was trying to buy out a business partner (amicably) but we held the property (a 4-plex) jointly as an LLC. Ultimately we decided not to proceed because he was unable to take his proceeds and use it towards a 1031. Since this was more of a convenience idea and there was no bad blood, we decided to just maintain the status quo until we want to sell the property completely so we can both use 1031.

Bill Exeter · Answer

Hi Matt,

There are also IRS Rulings whereby the taxpayer bought all (100%) of the outstanding membership interests in an LLC or the outstanding partnership interests in a partnership so that the entities effectively became single member LLCs and qualified as the purchase of replacement properties for their 1031 Exchange.

Bill Exeter · Answer

Hi Mark,

Yes, it would be allowed IF he bought through/with a single member limited liability company that would be considered a "disregarded" entity for tax purposes.  The disregarded entity means that it is treated as if he bought the property for taxes purposes, which would match the name that he sold his relinquished property under.

Matt Kvalheim · Answer

Thanks everyone for your input.  I certainly don't want to commit tax fraud!  I am working with my CPA on this as well, but I wanted to get thoughts from BiggerPockets community.

The "strategy" that I laid out, purchasing the LLC, is something I read about here on BiggerPockets about a week or two ago.  One of the benefits was to avoid R/E transfer fees and a potential tax reassessment.  But, I wasn't sure how legit it was and if anyone had actually done it successfully.

The lower cost basis on the property is a good point - I hadn't thought of that. If I do sell someday and don't 1031 exchange, that would come back to bite me. Thanks for that @Wayne Brooks

Mark Creason · Answer

I think what he wants to do is make the exchange into the LLC.  I do not know if that would be allowed.  CA has really high income taxes partly because the property taxes are so cheap.  CA properties get better each year because they can only go up 2%.  Tax assessor reassesses when property is sold.  I have a friend who owns a house in Rancho Palos Verdes.  He bought it for 105k back in 1975.  He pays about 2k a year in taxes.  Value today is over 2 million.

Mark

Wayne Brooks · Answer

@Mark Creason  Thanks, we have a similar thing for Homestead properties, but not for any LLC/non owner occupied properties.

John Thedford · Answer

@Dave Foster

Bill Exeter · Answer

@Matt Kvalheim @Hiba Exeter

Hi Matt,

Wayne asks a good question about whether your sale has already closed.  The 1031 Exchange must be set-up prior to any closing or it would be too late to structure a 1031 Exchange transaction.

Yes, the purchase of a single member limited liability company (LLC) would qualify as a purchase of real estate for your 1031 Exchange as long as the same person/entity that sold the 4-plex was the buyer of 100% of the LLC (in other words it became the sole member of the LLC).  A single member LLC is considered a "disregarded entity" for tax purposes and is therefore treated as if the underlying member was the buyer for tax (and 1031 Exchange) treatment.  This does not work if you buy the LLC and it is not a single member LLC because a multiple member LLC is not a disregarded entity and is actually treated as a partnership for tax purposes.

I'm not an expert on property taxes per se, but generally the acquisition of a property in California will trigger a reassessment of the property's fair market value for property tax purposes.  You should consult with your attorney to make sure that buying the interests in the LLC specifically to get around the reassessment action does not put you into any kind of tax fraud territory.

Bill

Wayne Brooks · Answer

@Bill Exeter will know.

But, does a sale affect reassessment there, it doesn't here,  properties get a new assessment every year, regardless of any sales.  You'd also be assuming a lower basis than what your purchase price would be.  Also, you say you "sold a 4 plex".  Has it already closed, and was the money placed with a QI?  If not, it's too late.

1031 Exchange - can I purchase a seller's LLC?

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