1031 exchange: selling as individual, buying as LLC?

Question

So, I have a property that is held jointly by my husband and me (title is in both our names). We'll be selling this as part of a 1031 exchange, and I would like to take title to the replacement properties in a LLC (with both of us as partners in the LLC) . I have read two things that are causing confusion for me. (First) that there is no problem doing this if you are an individual owner moving to a solo LLC because the IRS sees these as one and the same, and, (Second) that you can't sell as an individual and buy as a corporation.  I may be seeing problems that aren't there, but what does this mean for us as joint owners? Can we just move into a shared LLC? Or would we have to put the relinquished property into a LLC before we do the exchange? (All of our finances are joint, file taxes jointly, etc- if that matters..) Thanks for any clarification!

Dave Wood · Answer

Please be sure to get good advice from a tax lawyer.  It looks like you live in Colorado and are acquiring property in Ohio.  You may be covered by the laws of both states.  I once followed perfect advice from my accountant- only I had left out something that I thought was of no consequence. I was wrong and paid more in taxes than I would have had I given him all of the info.

Bill Exeter · Answer

Hi Jean,

It depends on the state that you live in.  The IRS came out with a ruling that says limited liability companies that have a husband and wife as the sole members and who live in a community property state would still be treated as a single member LLC and therefore a disregarded entity.

So, you could sell as individuals and then acquire the replacement property in a single member LLC/disregarded entity and be treated the same for tax purposes if you live in a community property state.

However, if you do not live in a community property state, then we have to assume, as this point, until the IRS rules otherwise, that the LLC would be treated as a partnership for tax purposes and it would not qualify for tax-deferred exchange treatment.  This would be the case whether you bought the property initially through the LLC or as individuals and then contributed the property into the LLC immediately afterward.

Megan Templeton · Answer

Hi @Art Webb,You can do this because the LLC would be pass through if single member. CPA can advise on tax portion for your wife.

-Thanks

Dave Foster · Answer

@Art Webb, You can do that as long as the LLC will only have you as the member and it elects to be taxed as a sole proprietor.  This has the effect of leaving the property to be reported on your personal return as it is now.  this LLC would be called a disregarded entity.

Interesting question on your passing.  Much is going to depend on your will and any estate planning you have done.  There are a couple of ways to still create the step upped basis for the property.  But good estate planning is key.

Art Webb · Answer

I’m considering selling my rental (in my name only) via 1031 exchange and buying my replacement property in a single member LLC for asset protection purposes.  Can I do this ?   Any hidden issues ?   Upon death does my wife receive the LLC property at a stepped up basis as if it had not been placed into a LLC ?   Thanks all !   Art

Bill Exeter · Answer

Dave T yes, that is correct.  They would have to make sure they treat the LLC as a single member LLC and not a partnership or corporation.

Dave Toelkes · Answer

Bill,

My interpretation is that the husband-wife LLC in a community property state COULD be treated as a disregarded entity if that is the election, otherwise the default is partnership.

Jean Bolger,

Ohio is not a community property state, so the spousal LLC will be treated as a partnership unless the corporation tax treatment is elected.  "Marital property state" simply means that any property acquired during the marriage by either spouse is considered marital property rather than individual property.  Should the parties divorce, each spouse is deemed to have an equal ownership interest when the property settlement is negotiated.

Bill Exeter · Answer

Dave Wood is right on the money.  Investors should always consult with their legal and tax advisors BEFORE entering into any agreement and/or completing/closing on any transaction - its money well spent.

Jean Bolger · Answer

Thanks! That's very helpful. The acquired property would be in Ohio; I had to look it up, but it seems they are not a community property state but what they call a marital property state. I guess I'd better talk to some Ohioans of the legal persuasion before I get myself in trouble ...

1031 exchange: selling as individual, buying as LLC?

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