Strategy Options for 1031 Exchange to Husband/Wife LLC

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Strategy Options for 1031 Exchange to Husband/Wife LLC

Alex P.
Oakland, CA · Member since 2016 · 9 posts · 2 votes

First time posting to the BP forum. Have to send a big THANK YOU to all of the folks sharing their experiences and information in this community. Very much appreciated.

I am in the middle of a 1031 exchange, having just sold a SFH rental in California and now closing in on identifying the replacement (leveraged multi unit commercial) property in Indiana, with the funds being held with a QI.

The relinquished property title was held only in my name, as I purchased it before marriage. Now married, I intend to hold the title of the new property in the name of the LLC that my wife and I will form for it.

As I understand it, single member LLCs are considered disregarded pass through entities. And LLCs owned by a husband and wife in community property states (like CA) can be considered disregarded entities. But LLCs in non-community property states (like IN) are treated like partnerships.

Aside from consulting with a CPA and real estate lawyer, I was wondering if anyone in the community has advice on best strategy here? The answer might be obvious to some, but I'm still trying to answer the following questions:

  1. If my wife is to be on the title, do we have to form the LLC in CA rather than IN so as to keep the disregarded pass through status to succeed with the 1031 exchange?
  2. Should I purchase the replacement property in my name and transfer title to LLC at a later date? I believe there are potential issues to sort out with the lender.
  3. Should I purchase the replacement property with new sole member LLC, then add my wife to the LLC later?

Thanks in advance for sharing your thoughts on this topic.

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Dave FosterBusiness Member
Qualified Intermediary for 1031 Exchanges · St. Petersburg, FL · Member since 2013 · 9k+ posts · 9k+ votes
10y

@Alex P., my guess is that you and your wife together are already the "tax payer" for that property. The issues of household and property status are different from the issue of identifying the tax payer for a 1031 exchange. If you and your wife file a joint return then both of you are the tax payer for that property because all activity of that property is reported on the sched E filed by the two of you together. Both of you may go on title to the new property as well. An LLC that does not file a tax return and issue partnership returns and whose activity is also reported on your individual tax return would be treated the same for 1031 treatment.

It is the tax return where the property is reported that will determine who is the tax payer for 1031 treatment.

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  • Dave FosterBusiness Member
    Qualified Intermediary for 1031 Exchanges · St. Petersburg, FL · Member since 2013 · 9k+ posts · 9k+ votes
    10y

    @Alex P., my guess is that you and your wife together are already the "tax payer" for that property. The issues of household and property status are different from the issue of identifying the tax payer for a 1031 exchange. If you and your wife file a joint return then both of you are the tax payer for that property because all activity of that property is reported on the sched E filed by the two of you together. Both of you may go on title to the new property as well. An LLC that does not file a tax return and issue partnership returns and whose activity is also reported on your individual tax return would be treated the same for 1031 treatment.

    It is the tax return where the property is reported that will determine who is the tax payer for 1031 treatment.

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  • Steven Hamilton IIPro Member
    Accountant, Enrolled Agent · Grayslake, IL · Member since 2011 · 5k+ posts · 2k+ votes
    10y
    Originally posted by @Alex P.:

    First time posting to the BP forum. Have to send a big THANK YOU to all of the folks sharing their experiences and information in this community. Very much appreciated.

    I am in the middle of a 1031 exchange, having just sold a SFH rental in California and now closing in on identifying the replacement (leveraged multi unit commercial) property in Indiana, with the funds being held with a QI.

    The relinquished property title was held only in my name, as I purchased it before marriage. Now married, I intend to hold the title of the new property in the name of the LLC that my wife and I will form for it.

    As I understand it, single member LLCs are considered disregarded pass through entities. And LLCs owned by a husband and wife in community property states (like CA) can be considered disregarded entities. But LLCs in non-community property states (like IN) are treated like partnerships.

    Aside from consulting with a CPA and real estate lawyer, I was wondering if anyone in the community has advice on best strategy here? The answer might be obvious to some, but I'm still trying to answer the following questions:

    1. If my wife is to be on the title, do we have to form the LLC in CA rather than IN so as to keep the disregarded pass through status to succeed with the 1031 exchange?
    2. Should I purchase the replacement property in my name and transfer title to LLC at a later date? I believe there are potential issues to sort out with the lender.
    3. Should I purchase the replacement property with new sole member LLC, then add my wife to the LLC later?

    Thanks in advance for sharing your thoughts on this topic.

    You may not want to add your wife to it due to community property laws. It was yours and if you keep it separate from her as was before marriage it is typically safe in a divorce.

    IN is not a community property state so you would have to file a partnership return if you and your wife own the LLC. In addition to that you WILL be subject to the CA $800 franchise tax. I recommend continuing to hold personally and to continue to keep it separate from your spouse.

    Oh and keep in mind CA may not recognize your 1031. In addition when you sell the replacement property you will have to make sure you pay the correct gainto CA.  https://www.ftb.ca.gov/individuals/1031_reporting_requirements.shtml#IYDNF

    [email protected]224-381-2660
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  • Alex P.
    OP
    Oakland, CA · Member since 2016 · 9 posts · 2 votes
    10y

    Thank you for the insights! I have a few follow up questions to make sure I'm understanding correctly.

    @Dave Foster

    So you're saying, in terms of the 1031, if my wife and I are filing jointly on sched E, it doesn't actually matter if the name on title is solely myself, a sole-owner LLC, or an LLC with my wife and I?

    @Steven Hamilton II

    "IN is not a community property state so you would have to file a partnership return if you and your wife own the LLC."

    Does this assume the LLC is formed in CA, IN or in either case?

    "In addition to that you WILL be subject to the CA $800 franchise tax."

    Are you saying that regardless of the state the LLC is formed in, because our joint return is filed in CA, it will be subject to $800 CA franchise tax?

    "Oh and keep in mind CA may not recognize your 1031."

    Are you saying CA may not recognize the 1031 due to the replacement property being held in an LLC?

    Noted on the recommendation to hold personally.

    Thank you for your clarifications.

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  • Marco G.
    Investor · Dallas, TX · Member since 2015 · 446 posts · 197 votes
    10y
    Alex P. Unless you owned the SFH outright BEFORE you got married, I disagree with Steven Hamilton II that now doing a 1031 into a jointly held property has community property consequences. Title does not control in CA. It can get expensive, but the funds could be traced/sourced and apportioned. There is no automatic transmutation based solely on how title is held. Often the issue arises when community property is used to acquire property as the sole and separate property of one spouse, but the concepts works in both directions: http://www.berenjifamilylaw.com/community-property-concepts-transmutation/
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  • Marco G.
    Investor · Dallas, TX · Member since 2015 · 446 posts · 197 votes
    10y
    Alex P. I would definitely seek a quick consult with a CA family law lawyer if this is a concern.
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  • Steven Hamilton IIPro Member
    Accountant, Enrolled Agent · Grayslake, IL · Member since 2011 · 5k+ posts · 2k+ votes
    10y
    Originally posted by @Alex P.:

    Thank you for the insights! I have a few follow up questions to make sure I'm understanding correctly.

    @Dave Foster

    So you're saying, in terms of the 1031, if my wife and I are filing jointly on sched E, it doesn't actually matter if the name on title is solely myself, a sole-owner LLC, or an LLC with my wife and I?

    @Steven Hamilton II

    "IN is not a community property state so you would have to file a partnership return if you and your wife own the LLC."

    Does this assume the LLC is formed in CA, IN or in either case?

    "In addition to that you WILL be subject to the CA $800 franchise tax."

    Are you saying that regardless of the state the LLC is formed in, because our joint return is filed in CA, it will be subject to $800 CA franchise tax?

    "Oh and keep in mind CA may not recognize your 1031."

    Are you saying CA may not recognize the 1031 due to the replacement property being held in an LLC?

    Noted on the recommendation to hold personally.

    Thank you for your clarifications.

    Alex, It does not matter where the LLC is created as you will have to foreign qualify in the other state. CA WILL make you subject to it as the management is considered doing business. Even sending an e-mail is considered doing business in CA. They are very very aggressive. I have a client who refused to file the CA return and later got hit with an almost $2k penalty.

    For the 1031, I am saying CA requires a certain form filed annually to trace and track the replacement property. If you do not file it they will advance their collection of the deferred gain.  I would insure it very well.

    If the LLC operates in a non community property state you could lose the opportunity to treat it as disregarded you will run into issues as the non community state will be expecting a partnership tax return. In fact I'd suggest treating it as a partnership as it lowers your chances of audit due to partnerships being audited less often.

    The expense and complication is why I suggest insuring VERY WELL is and holding personally or using a trust. 

    [email protected]224-381-2660
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  • Steven Hamilton IIPro Member
    Accountant, Enrolled Agent · Grayslake, IL · Member since 2011 · 5k+ posts · 2k+ votes
    10y

    @Marco G. I completely agree a CA attorney should be consulted on this.  

    [email protected]224-381-2660
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  • Alex P.
    OP
    Oakland, CA · Member since 2016 · 9 posts · 2 votes
    10y

    Thanks @Marco G. and @Steven Hamilton II. I'll report back after consulting with a CA attorney if there's anything to add to the advice given on this thread.

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