Does anyone have experience with 1031exchanges and LLC's?

Question

I presently have a property in NJ that is in an LLC and I would like to sell it and buy investment properties in NC. I'm unsure as to what the first steps are that I should take OR if having the property in an LLC affects the process. My questions are as follows:

1. What step do I take first? Do I set up and LLC in NC as the first step before buying property, then find a property here I'm interested in then sell NJ property and then place those funds into 1031 exchange and then purchase the NC property via the NC LLC. If someone could write out the steps for me in order of how to proceed that would be great.

2. Where do I find legit folks to hold the funds for the 1031 exchange?  How does that work?

3. When do I go about dismantling the NJ LLC when I switch over to an NC LLC and is it a long and difficult process?

4. What if I find one property to buy but am not able to utilize all funds from the 1031 on time to purchase another? For example, what If I make 300,000 on sale of NJ property but am only able to spend 200,000 on another rental before the deadline?

Any advice would be greatly appreciated.

Dave Foster · Answer

@Chris L., What I meant to convey was that if you only had a 100K gain and then bought a property worth 100K less than what you sold for a 1031 wouldn't be worth it.  the reason is that the IRS views every dollar you take in cash and every dollar you buy down as a taking of profit.  so if you had a 100K gain and bought down 100K you would pay tax on all your profit anyway so there wouldn't be a reason to do the 1031.

There's no magical threshhold.  It's all in the preferences of the client.  But in the above scenario, if you had a 100K gain and bough 50K less than what you sold, you would pay tax on the 50K and shelter the other 50K of gain.  So you can play with the sliding scale to see where your comfort level comes.

Basis - not quite but close.  If you had a 200K cost basis and $100K in gain for a $300K sale and matched your 1031 reinvestment requirement exactly by purchasing a $300K property your basis in the new property would still be $200K so if you sold that property the next day for $300K without doing a 1031 you would recognize the $100K gain that was on the old property.

However if you purchased for $400K then you are in essence buying another $100K of depreciable basis.  So the basis in your new property that you purchased for $400K is $300K.  So again if you sold it the next day for exactly what you paid for it without a 1031 you would recognize a gain of $100K or exactly what you had deferred forward in the new property.

This does play into your follow up question on QI costs.  The normal range for good national firms with experience and providing personal consulting is between $750 - 1000.  You can pay a lot more more an attorney who does 5 a year.  You can pay a bit less if you just want to fill out some internet forms and swing at a high outside fast ball.

Dave Foster · Answer

@Chris L., You're basis comes into play when determining your potential gain and whether to do a 1031 or not.  If you decide to do a 1031 the basis carries forward into the new property.  So the requirements to defer all tax are purchase at least as much as you sell and use all of the proceeds in the purchase.  In your example, you are selling for 200K and need to purchase for 200K  in order to defer all tax.  Now the 2nd part of that rule is that you must use all of the proceeds in the purchase.

So assume for a minute that there was a $100K loan on the property.  In total you would need to buy at least $200k and use all $100k in proceeds to do that.  If you buy for 100K only then you would incur the tax on the 100K that you bought down.  And since you only had 100K in gain to begin with there would be no advantage in using the 1031.  Sales price not gain.

Your intermediary can be anywhere.  Experience nationally is key.  There are several intermediaries even on this site that are located in one place but work nationally.  Some have staffed satellite offices like us.  Some have one central location.

If you want to tag anyone in a forum just type @? and a pop up of contributors on that thread will pop up and you can select one.  Other than that you can always tag your colleagues with the @ symbol followed by their name.

Dave Foster · Answer

A qualified intermediary is who you're looking for to administer your 1031 exchange.  They must be an unrelated 3rd party whose only role is the administration of your 1031 exchange.  They document and transfer the funds from closing to closing so you do not have receipt of the funds.  The 1031 and intermediary must be in place prior to the closing  of your sale.

Regarding the LLC.  Any tax paying entity can do a 1031 exchange.  The key is that the tax payer for the old property must be the same as the tax payer for the new property.  However it's not always clear who the tax payer really is.  If your NJ LLC is a single member disregarded entity (meaning it doesn't file its own tax return and all activity of that property is shown on your own tax return schedule E) then the IRS really perceives that you are the tax payer for the property regardless of what LLC name is on the deed.  So it would be possible to sell as the LLC and 1031 buying as yourself or as a new NC LLC that is also disregarded.

However, if that NJ LLC files it's own tax return then it is the tax payer and it will have to sell and do the 1031 and buy the new property.  After the fact you can certainly form another entity to hold the property (or the NJ LLC in) but that is after the 1031 is complete.

In order to defer all tax you must purchase at least as much as your net sale ( contract price less normal costs of closing) and use all of the net cash (net sale minus mortgage payoff) in the next purchase or purchases

You can purchase less than what you sell or take cash out but the IRS says that when you do that  you are first taking profit out.  So you would pay tax on the difference but shelter the remaining profit from tax with the 1031.  This is called a partial exchange and can be a strategic move - pay some tax shelter some tax.  One other thing you could consider is buying two properties to eat up the entire amount.  It is the values not the number of property that is important.

Bill Exeter · Answer

Hi @Chris L.,

There is no real threshold for when or when not to structure a 1031 Exchange, but I would use the amount of tax that you would have to pay as your decision point.  If you are going to defer $100,000 in gain, which is likely $30,000 ish in actual taxes, then a 1031 Exchange makes sense.  If you trade down so far in value that you are only going to defer a few thousand dollars in taxes - or none if you trade too far down in value - then the 1031 Exchange may not make sense.

Qualified Intermediary fees vary between $750.00 and $1,200 on the west coast and can be up to $2,000 sometimes on the east coast.  Some "QI's" that do relatively few or offer tax or legal advice with the 1031 Exchange may charge considerably more.  BE VERY VERY CAREFUL if the QI is charging significantly less than these amounts - Buyer Be Ware! You want your QI to be around for a long long time, and they need to charge enough to make a profit so that they will be around.

Bob Floss II · Answer

I don't know NC law, but in many states you can keep your current LLC and file with the same LLC in the new state as a foreign entity.  It involves paying to keep the LLC alive in your originating state and paying to do business in your new state, but it saves you from having to pay to form a new entity and setting up a new business.  It also makes the process of completing the 1031 smoother since you are taking title in the same entity.

As always, please consult with a NC attorney on their state and local laws.

Chris L. · Answer

@Bill Exeter  @Dave Foster

What does a qualified intermediary cost-avg?

Chris L. · Answer

@Dave Foster

You mentioned above that if there is $100,000 gain that it may not be worth it to use a1031exchange. Is there a threshold or number       That would make it worth it to use a 1031 exchange?

Also, you mentioned that the cost basis of original property is carried over to new properties so then if the original house cost basis was 200,000 then regardless of the price of the new properties purchased the cost basis will remain at that of the original property I sell. Is that correct?

Bill Exeter · Answer

Hi @Chris L.,

There are some nuances that may come into play when structuring 1031 Exchange transactions through a limited liability company.  The nuances vary with each 1031 Exchange and often depend on whether there is any financing involved of if the Replacement Property is an all cash transaction.

Individuals or any type of legal entity can structure a 1031 Exchange transaction, but the person or entity doing the actual 1031 Exchange must be the same on the sale of the Relinquished Property as it is on the purchase of the Replacement Property.  If John Smith sells Relinquished Property, then John Smith must buy the Replacement Property in order to have a successful 1031 Exchange.  The same goes for entities.

Your Relinquished Property is owned by an LLC in New Jersey.  The same New Jersey LLC could be used to acquire your Replacement Property in North Carolina.  You might also be able to set-up a new LLC in North Carolina instead of using the same LLC depending on a number of issues. The critical issue is determining who the actual taxpayer is.  Is it the LLC or is it the sole member of the LLC?

Are you the sole member of the NJ LLC?  If so, it is likely considered a disregarded entity (check with your tax advisor to make sure that it is a disregarded entity).  Disregarded entities are ignored for income tax purposes and treated as if you owned the underlying real estate (assuming that you are the sole member of the LLC).  This means that you are really the taxpayer (and not the NJ LLC) for income tax purposes.  If this is the case, then you could acquire your new property in/through your NC LLC as long as you are also the sole member of the NC LLC (and that it is a disregarded entity as well).  Multiple members LLCs or LLCs that are not considered to be disregarded are treated differently for income tax purposes.

You need to retain the services of a 1031 Exchange Qualified Intermediary to administer your 1031 Exchange transaction.  Look for a QI that has lots of experience and expertise.  This is important so that they can walk you through the entire transaction and keep you out of trouble.  Google something like "choosing a safe 1031 Exchange Qualified Intermediary" and you'll find lots of articles out there on what to look for.  You do not need to retain a "QI" in the state that you and/or the properties are located in.  Those of us who have been doing it for a longer time cover all 50 states (we even cover foreign property exchanges).

The formation and dissolution of the LLCs should be completed by an attorney or service that specializes in that.  Do not try to do it yourself unless you really know what you are doing.  It is a relatively easy process, but can be an absolute nightmare if you screw it up.

Partial 1031 Exchanges are O.K. as long as you understand that you will be paying some taxes on the transaction.  Your tax advisor can help you determine whether a partial 1031 Exchange (selling for $300,000 and only reinvesting $200,000) would defer any tax liabilities and provide you with a tax benefit. Trading down is often done for strategic reasons, but you need to know exactly what your tax consequences are going to be before you proceed.  However, to defer all of your taxes you must acquire one or more properties that have a combined purchase value that is equal to or greater than the sale price of your Relinquished Property.

Chris L. · Answer

Does the intermediary have to be in the state in which you sell the property or can it be in the state in which you buy the new property?

Chris L. · Answer

Hi Dave,

When you say to use the full amount, do you mean using the full amount that I received from the sale OR using the full amount that is over original cost basis.

So if the cost basis is 100,000 and I sell for 200,000 and I put the 200,000 into a 1031 exchange and use 100,000 of it to purchase a new property do I then avoid the taxes on the 100,000 gain or do I have to use all of the 200,000 from the sale of the house to avoid taxes?

Does anyone have experience with 1031exchanges and LLC's?

Most Popular Reply