Sale of a percent ownership - does it qualify for 1031?

Question

If I sell my 22% ownership of a warehouse to one of the other owners, does the sale qualify for a 1031 exchange? It has generated income for many years. The property itself is not being sold, just my percentage of it.

Daniel Osman · Answer

@Cole Bossert is spot on. Sselling your 22% ownership interest in a warehouse to one of the other owners would not qualify for a 1031 exchange. The exchange must involve real property not partnership interest.

@Craig A. How is title held on the property?

Cole Bossert · Answer

A 1031 exchange is typically used for the sale of real estate, not ownership interests. So, if you’re selling your 22% stake in the warehouse, that doesn’t usually qualify for a 1031 exchange since you’re selling an interest in the partnership or LLC, not the actual property itself.

For a 1031 to apply, the exchange must involve “like-kind” property, which in this case would be a direct sale of real estate, not a sale of ownership shares. You might want to consult with a tax professional to explore any alternative options, but as far as 1031 exchanges go, you’d be looking at a no-go for this kind of transaction.

Craig A. · Answer

Another question:

This pertains to the above commercial property.

If a partner in an LLC dies, does the basis step up for a surviving spouse or other heirs?

How would the new basis be determined? Does an appraisal determine the new basis?

Craig A. · Answer

I should have asked this before.

Suppose we leave the partnership as an LLC and all agree to sell at a later date, meaning that we sell the entire property. Would my percentage then qualify for a 1031 exchange?

Craig A. · Answer

Let me run some numbers by you (anyone who is interested). What would you do? I'm 86-years-old (I could live ten more years). My health is currently pretty good, but not great. I have a wife and children - they would receive a stepped-up basis on my death. Business has been soft at the warehouse, but it is well-located, in good shape, and I expect business to perk up over the next five years. For "SELL LATER", below, I'm thinking that the family of the majority owner will want to sell when they receive a stepped-up basis upon the patriarch's death (this is a gamble on my part). He's 75-years-old, it could be twenty years. I/my family can afford to wait that long. I do not need the money right now, but who doesn't like cash, right? And I could find uses for the cash. He has offered to buy me out now, at the "SELL NOW" price. The "SELL NOW" price includes a 25% reduction from appraised value that applies to minority buyouts. 4% is a rough number for T-bills. The business is located in California and I live in Arizona. My share of current income on the business is $130,000, but I'm being conservative below, as a reduction is expected. This is an LLC.

SELL NOW proceeds:                                        $3,750,000

Less Tax (3,750,000 x 0.333)                              1,248,750

Net                                                                         2,501,250

Income after sale:  (2,501,250 x 0.04)                                                                                                     100,050

KEEP- then sell (IF the whole business is sold later)(in today's dollars)

Appraised value                                               $26,750,000

Minus debt                                                            5,003,000Minus closing costs (7%)                                                                                                                        1,872,500Net on sale                                                          19,874,500

My share (22%)                                                     4,372,390

Less Tax on future sale (1031-ed or stepped-up basis)                                                    0

Net                                                                           4,372,390Income while holding (allowing for poor business performance)                              75,000 to 100,000 annuallyIncome after sale (4,372,390 x .04)                                                                       174,895 annually

I want to hold onto it, but I'm receiving family advice to sell now. Bottom line though, what is best, by the numbers? I realize there is a lot you don't know about family dynamics, the location, market, etc. Assume this is a prime San Francisco Bay location. I'm taking votes, if anyone is game. SELL NOW? Or KEEP?😉

Daniel Osman · Answer

You could see if your partners would be interested in a drop and swap. The LLC distributes the real property to its members as tenants-in-common (TIC) interests. This means that each member receives a direct ownership interest in the property, rather than holding an interest in the LLC that owns the property.Once the property is distributed, the members hold their interests directly. This allows them to individually manage their interests, including selling their share or engaging in a 1031 exchange.By holding the property directly, a member can sell their TIC interest and use the proceeds to acquire a like-kind replacement property in a 1031 exchange. This allows the member to defer capital gains taxes on the sale of their interest.

Craig A. · Answer

Thanks, guys. That aligns with what I've been told. You rock.

Craig A. · Answer

The title is held as an LLC. Why does that matter?

Sale of a percent ownership - does it qualify for 1031?

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