Trust/Ownership issues with 1031 Exchange

[Justin R.]

My wife and I are currently in the process of creating a trust which will hold all of our long term rentals. I am also looking to sell one of my out of state properties. I contacted my exchange company to set up my 1031 process, and they informed me I could be held responsible by the IRS for back taxes, penalties, and legal fees if I get audited. The exchange company said that depending on the IRS auditor (in the scenario I was audited) they would see that the property was purchased in my name (solo), and then placed into a trust with both my wife and my name, therefore eliminating 50 percent of the exchange benefit.

My Attorney setting up my trust (out of state) does not think this is an issue because California is a "common law" state, My Exchange company thinks there is a sizable chance of this happening, and my CPA is split between the two. My CPA is most concerned with the properties I held prior to marriage being treated differently by the IRS, but feel they could all be scrutinized.

This is a huge deal for me because if I lose my ability to 1031 exchange with all of my properties that could be disastrous. 

Hopefully someone who is familiar with CA law chimes in as well as anyone else with experience in this dilemma. Thank you in advance!!!

[Dave Foster]

@Justin R., So far I'm not hearing the real issue and I don't think the QI involved is getting it from what you've said.  There are only two ways to go with this.

1. Is the trust a disregarded entity? - If you're setting up a revocable trust (it does not have a tin and does not file it's own return) then that trust is not looked at by the IRS and the taxpayer is the trustee of the trust.  That would be you.

2. If the trust is an irrevocable trust with it's own tin and filing it's own tax return then it is a regarded entity and viewed by the IRS as the tax payer for the property.  So you are changing the taxpayer of the property right before a sale and 1031.  That is a no no.  But easily solved - you simply complete the 1031 and then contribute the property into the trust.  

the community property issue is really moot for 1031 as community property is a state legislated designation and 1031 does not speak to that.  To qualify for a 1031 exchange the tax payer for the old property must be the tax payer for the new property.  If you and your wife file a joint return then from the federal perspective you and she (or rather the tax return that reports the activity of the properties - all of them both from during your marriage and before your marriage) are one and the same tax payer.