An important rule to keep in mind when considering a 1031 exchange is that in order to gain tax deferral benefits, title to the replacement property must be held using the same tax ID of the property that was sold. This “same taxpayer’ requirement is not a serious concern when a single owner is completing an exchange, but can be come problematic if the investment property is owned by multiple owners under certain ownership structure such as LLCs, LLPs, C-corporations, S-corporations, etc. Problems can arise in these types of group ownership structures when partners or members wish to go their separate ways after a 1031 exchange is completed.
Can You Change Ownership in a 1031 Replacement Property?
It may be possible to change the ownership of the 1031 replacement property provided several important conditions are met.
Changing ownership soon after an exchange is completed is very likely to raise the risk of the exchange being disallowed due to violating the “same taxpayer” concept. However, many tax advisors will support changes to the ownership when the exchange has become “old and cold.” While there is no written minimum holding period in the tax code, a prudent recommendation by many tax professionals would be hold the property in same ownership form for at least several years. After passage of an appropriate amount of time and, subject to validation from a qualified tax professional, participants in group ownership structures such as LLCs can be bought out by other participants and exit property ownership.
Participants in ownership structures such as LLCs may elect to convert the form of their ownership into a Tenant-in-Common (TIC) structure. The IRS allows participants in a TIC (and also a DST) ownership structure to be treated as individual owners who can independently pursue reinvestment strategies without being tied to what other fellow co-investors decide to do. Tax advisors generally advise clients who plan to convert an LLC structure into a TIC structure to do so after a significant time has passed since their exchange was completed – or convert the ownership of the relinquished property to a TIC well before the exchange is completed. When TIC or DST owned property is sold, participants may immediately go their separate ways and still be permitted to complete a follow-on 1031 exchange.
Investment replacement properties may also be placed in revocable living trusts after a 1031 exchange without triggering a potential tax liability.
TICs, DSTs, and revocable trusts are each considered a “disregarded entity” by the IRS. While they are separate legal entities that may limit an owner’s liability, for tax purposes they’re treated as part of the owner’s personal activity. Any investments held in the name of these entities use the same tax ID number as the individual owner. Therefore, these changes in title will not cause a 1031 exchange to fail.
Changing Ownership Between Spouses
If a married couple jointly owns the relinquished property, the replacement property should be held in the same way. If only one spouse is on the title to the relinquished property, a situation may arise when either the property owner or the lender wants to add the other spouse to the title.
Since the relinquished property was sold by a single owner and the replacement property technically has two owners with separate tax IDs, this could cause the exchange to fail, at least in part. In most cases, CPAs and other tax advisors recommend keeping the title exactly the same and waiting several years before making any changes.
If a lender mandates that a spouse be added to the title, investors should request documentation showing the title change was due to financing requirement and not done by them to avoid tax liability.
If you’re making any changes to the title of your replacement property, it is highly recommended that you communicate planned changes to knowledgeable third parties such as your tax advisor, estate planner, financial professional, or attorney and have them confirm that your intent in making the change was other than to avoid potential tax liabilities.
If you plan to complete a 1031 exchange after an ownership change it is also critical to inform your Qualified Intermediary (QI) of the details. This will help prevent you from inadvertently making a change that is not allowed and ensure all exchange documentation and instructions reflect the new entity and share interest.
Working with a team consisting of a qualified tax advisor, attorney, and financial professional who are all well-versed in the nuances of a 1031 exchange will help you stay within the required parameters of the tax rules.
To learn more about your options, contact us at email@example.com for a consultation.
Please note that we are not able to provide specific personal tax advice and you should consult with your team of professional tax and legal advisors prior to making any changes to ownership. If you need referrals to tax and legal professionals, please contact us.