1031 Exchange question-condo conversion

[Wayne Brooks]

@Bill Exeter @Steven Hamilton II, other experts....

I think I know the answer, but want to verify.  Apparently his current CPA thinks Yes to # 1).

Owner has owned 5 plex for 30 years.  He thinks he can convert to condos, then 1031 the proceeds from the individual condo sales.  Approximate as is value $1M  As condos, $1.6M.

1)  After doing the condo conversion to 5 individual units, would the proceeds still qualify for a 1031?

2) If not, could he sell the 5 units, as is, from say John doe LLC (current name titled in) to a separate LLC where he is the sole member (John Doe LLC #2) for FMV of $1M, 1031 those proceeds, then let John Doe LLC #2 do the conversion and sell the units, and I assume pay ordinary income on the profit. The "non arms length" portion of this idea concerns me.

Any other suggestions?

Thanks.

[Bill Exeter]

Originally posted by @Wayne Brooks:

@Bill Exeter @Steven Hamilton II, other experts....

I think I know the answer, but want to verify.  Apparently his current CPA thinks Yes to # 1).

Owner has owned 5 plex for 30 years.  He thinks he can convert to condos, then 1031 the proceeds from the individual condo sales.  Approximate as is value $1M  As condos, $1.6M.

1)  After doing the condo conversion to 5 individual units, would the proceeds still qualify for a 1031?

2) If not, could he sell the 5 units, as is, from say John doe LLC (current name titled in) to a separate LLC where he is the sole member (John Doe LLC #2) for FMV of $1M, 1031 those proceeds, then let John Doe LLC #2 do the conversion and sell the units, and I assume pay ordinary income on the profit. The "non arms length" portion of this idea concerns me.

Any other suggestions?

Thanks.

Hi Wayne,

I'm not quite as optimistic as Dave regarding the first option.  We have been involved in a number of transactions that involved subdivisions where the client essentially only obtained/filed the subdivision map and did/made absolutely no building or improvements and the 1031 Exchanges were disqualified under audit.  The condo mapping process is very similar, and the risk is that the auditor could take the position that the taxpayer intent was to hold for sale and not for investment purposes. 

The second option would be a problem if the LLC was a single member LLC because it would be treated as a disregarded entity and therefore the same taxpayer. However, we have structured transactions where the entity that bought the asset before mapping was not owned by the current taxpayer (or only partially owned by him). I think the second option is safer given the risk that the intent could be questioned in option number one.

Dave is right that you must be careful with the related party rules, which could be a deal breaker if structured incorrectly.