1031 Exchange, Like Kind Property

[Donald D Michna]

I was at a meetup the other night and a CPA came to speak with us. I spoke to him on an individual level after the meeting about a 1031 exchange that a family member is looking to move from one property to a like kind property. I was planning on partnering with the individual once we purchase the like kind property together. After the meeting he followed up with me and indicated the following “The same person that owns the property given up must receive the replacement property. With both the property given up and the property received, the intent of the property must be to hold by that person and use as an investment, a rental, or in a business. Moving it to another entity, even if for those same reasons, shows your intent was not to hold. The advice is to hold for 12-24 months (2 tax returns), and then intentions change, and it can be contributed to a partnership.” Does this sound accurate? I intend to be apart of the like kind deal but also do not want to make the 1031 exchange null and void. Thanks in advanced.

[Dave Foster]

@Donald D Michna, Some of that is accurate.  Some is not and some is opinion (which is always good in the eyes of the speaker :)

1. It is the tax payer that must stay consistent and sell, perform the 1031, and purchase the replacement real estate. This does not necessarily mean who is on the deed. It is the tax return that reports the activity of the property. Case in point. If the target property was owned by an LLC of which your family member was the only member and it did not file it's own tax return, then even though the LLC is on the deed it would be "disregarded" by the IRS. And your family member is really the tax payer because the property is reported on their personal Schedule E.

You definitely do not want to become part of the 1031 as that is prior to the exchange and the IRS has demonstrated they don't like that.  After the 1031 it's not so cut and dried.

2. It depends on what you mean by partner.  Whoever the tax payer is for the old property must also be the tax payer for that much new property.  But it would be fine for you to also own a tenant in common % of the new property.  You would each be tenants in common and could structure an operating agreement accordingly.

3. Contributions into and distributions out of entities are generally not taxable events.   The IRS is much more concerned with an entity transfer immediately prior to a sale and 1031 than they are with an entity change after a 1031 is complete.  In particular if there's a reason like liability, management, adding someone to ownership for an operations consideration.  You're not selling the property and recognizing your gain.  You are simply changing circumstances of ownership.

You definitely do not want to become part of the 1031 as that is prior to the exchange and the IRS has demonstrated they don't like that. After the 1031 it's not so cut and dried.

4. The two year period is a lovely mythological example of an attempt to make sense of statute and case law where there is no sense.  There is no statutory holding period!  Two years or two tax returns stems from the period outlined in the safe harbor or rev proc 2008-16 and referred to in a couple case rulings as two years, two calendar years, and two tax years (appropriate times not recommended or required times).  Adding . up the possibilities that's anywhere from 2 days to 760 days.  So what he's really saying is to make it transparent by putting it on two consecutive tax returns.  Which is why there used to be a mantra in the industry of "one year and one day".  But that was proven to be false as well.  Because no one knows for sure - It's all about your intent and the reasons surrounding the change in reporting.

5. So you could go the tenants in common route immediately if the valuations support it. Or they could take title as a disregarded LLC and then add you as a member (with your contribution) after the 1031 is complete. Or you could form a new LLC and they contribute the property and you contribute your good looks again after the 1031. whether 2 days or 2 years after is appropriate is up to the individual circumstances.