Selling Real Estate under an LLC and using a 1031

[Mark Simon]

It's been a while since i posted anything.  I'm currently the owner of a couple long term and a couple short term rentals.  My second long term was just purchased via a 1031 exchange after selling our third short term rental.  We are selling off our beach properties due to the rising costs of everything beach related, and the aggravation of property management companies.  Our experience in the North Myrtle Beach area was painful at times.  Area became oversaturated with rentals, cleaners sucked, property management was lack luster to say the least.  Anyway, the real purpose of this post is to share some learnings from this recent sell.  

Our North Myrtle Beach rental was our first rental, and the first rental we have sold. After purchasing it, we put it into an LLC, including putting the deed in the LLC. Fast forward to the sale and 1031 exchange, i began the application for a mortgage since the 1031 amount was about 60% of the purchase price of the new property. Naturally, the lowest mortgage rate was my goal, so i started applying for mortgages. Narrowed down to two banks and was negotiating with them. My offer to the owner was in my name. Why would i do anything else? Here's why. When doing a 1031 exchange, the name in which the sold property is recorded is what the offer needs to be in when purchasing the new property. So, in this case, the condo i sold had the LLC name on the deed. Therefore, my offer, and my mortgage i was applying for needed to be in the LLC name. Not mine. Simple fix right? Yes, but now that changes my mortgage application from a residential loan to a commercial loan. Which are a point or more higher than your standard residential rates. Some banks who offer commercial loans usually also have a shorter payback period. So, when you consider all of that, you may find yourself with a smaller cash flow.

So, what did i learn?  Not to have the deed in anything other than my name if i intend to do a 1031 exchange.  Change the deed prior to selling if the deed is currently in a business name.  I also learned that you can purchase up to three properties thru a 1031 exchange.  I was always under the impression that you could nominate up to three, then close on one prior to the expiration time period.  Our exchange lawyer did not communicate that very well i think.  Additionally, when negotiations between realtors is occurring, things not documented in writing don't hold up.  Verbal agreements and understandings don't hold up.  We got burned a little at closing due to the imprecise verbiage in the repair credit documentation.  And if you are dealing with a difficult seller, and a shady sellers realtor, you'll be the one screwed over.  

Cheers!

[Myrtle Mike Thompson]

@Mark Simon thank you for sharing your experiences! I have felt several of those same pains at times while brokering deals and helping my clients navigate the STR market here in Myrtle Beach and North Myrtle. A good property manager is absolutely paramount if you're not going to self-manage. I hope you at least saw some nice appreciation, and I wish you all the best with your new purchase!

[Michael Smythe]

If it's not in writing - it NEVER happened.

[Cindy Cheng]

Hi Mark!

I thought LLC's can only do a 1031 exchange if they terminate the LLC? Those exchanges are called Swap and Drop/Drop and Swap. They're more complicated and take longer to fully conclude. If there's another method, please let me know.

I also have a property under an LLC (my husband and I are only members) that I want to do a 1031 with. I was also told by my cpa that transferring the property from the LLC to our personal names will trigger a tax event.

[Dave Foster]

@Mark Simon, There's actually a lot that your 1031 intermediary/attorney didn't tell you that would have been helpful. Depending on the nature of that LLC you could have gone ahead and taken out the new loan in your name and saved yourself all of that extra expense. If the LLC you set up was taxed as a sole proprietor then it would not file a tax return. All of the activity of the property remains on your personal tax return. In that case you can sell as the LLC and purchase in your name.

You can purchase as many replacement properties as you want.  the limitation is on the identification of them.  If you identify 3 or fewer then it doesn't matter how much they are worth.  If you identify more than 3 then either the total value of the list cannot be more than 200% of the value of what you sold.  Or you have to purchase 95% of the value of the list.  So there are many options other than just naming 3 and purchasing one.  I'm sorry you got that counsel from the intermediary.

@Cindy Cheng, Any tax paying entity can do a 1031 exchange. The key is that the tax payer for the old property be the same as the tax payer for the new property. If your LLCs do not file their own tax return and all of the activity of the property is reported on your personal tax return then you can sell as the LLC and buy as yourself. It doesn't change the tax payer.

But further to your case I'd question your accountant's advice. In general contributions into and distributions from an LLC to individual's names are not taxable events. Either the LLC is dissolved and the property goes into your name at it's basis in the LLC. Or the LLC continues and your capital account in the LLC is reduced by the distribution and switched to you at it's basis - either way, not taxable.

A drop and swap is not any more complicated and takes about 10 minutes for a title company to do.  They are frequently done right before a sale and do not impact the transaction calendar at all.