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How to Use a Trust in a 1031 Exchange for Your Estate Plan or Privacy

Trusts are frequently used in 1031 exchanges for estate planning purposes or privacy. However, a trust must be used correctly to preserve the tax benefits of the exchange.

"Continuity of investment” is one of the requirements for a successful 1031 exchange. To qualify, investors must show that the relinquished property and the replacement property are both owned by the same taxpayer. However, as is the case with many real estate transactions, there are some exceptions. The following guide briefly explains the role certain types of trusts can play in a 1031 exchange and how the continuity of investment rule applies.

Trust Basics and Benefits

There are many different types of trusts, each designed to obtain a different objective. For the purposes of a 1031 exchange, investors will often use a revocable trust, irrevocable trust, or a land trust. One of the primary objectives of many trusts is to allow the property held inside to avoid probate before being passed on to beneficiaries. Some trusts also provide property holders with additional privacy. 

Typically, there are three parties to a trust:

  • Grantor (also called Settler) – the creator of the trust
  • Trustee – the individual responsible for administering the trust
  • Beneficiary – the individual who benefits by receiving the assets after the death of the grantor

In some types of trusts, the same individual may fill multiple roles. 

Revocable Living Trusts

A revocable living trust is one of the most common trust types. These trusts can be amended or revoked at any time while the grantor is living. They’re also defined as “disregarded entities,” as they do not file independent tax returns. Instead, all gains, losses, income, and expenses are reported on the grantor’s tax return. For this reason, revocable trusts meet the continuity of investment requirements. 

In many cases, the same individual is the grantor, trustee, and beneficiary of a revocable living trust. This allows the taxpayer to 1) sell a relinquished property held by the trust and 2) purchase a replacement property as an individual or a single-member LLC (or the other way around). 

It’s important to note that when a revocable trust owns a property, either the grantor or the trustee is considered the taxpayer. If a different individual has been named as the beneficiary, he or she is not considered the taxpayer, and therefore cannot directly benefit from a 1031 exchange. 

Irrevocable Trusts

One of the primary differences between an irrevocable trust and a revocable trust is that once they’re created, irrevocable trusts cannot be modified or revoked. These trusts effectively remove all ownership rights from the assets placed inside, allowing individuals to remove the assets from their estate. 

Irrevocable trusts have their own tax ID number and file separate tax returns. As such, they are not considered disregarded entities. Since the trust is considered the taxpayer, an investor who sells a relinquished property held by an irrevocable trust must also purchase the replacement property inside the same irrevocable trust. 

Land Trusts

A land trust is a legal entity that holds the title of a piece of real estate property for the benefit of a beneficiary, who is typically the taxpayer or a limited liability company that holds operational control of the property. These arrangements often include a trust land agreement between the property owner (taxpayer) and the trustee, allowing a beneficial interest in the property. In these cases, public records will only show the trust and the trustee as the property owner, allowing the taxpayer to remain anonymous. 

Land trusts date back to England’s King Henry VIII and even ancient Rome. Illinois became the first state in the US to codify land trusts with a favorable ruling by the state’s supreme court in the late 1800s. Today, land trusts in a variety of states are considered interests in real property, making them eligible for a 1031 exchange. However, it’s important to note that land trusts with more than one beneficiary must follow certain rules to avoid being deemed a partnership, as partnership interests are not 1031-eligible. 

Delaware Statutory Trusts

The Delaware Statutory Trust (“DST”) is used to facilitate ownership of property by multiple owners. In a DST, legal title to a property is held by a trustee, and investors can purchase “beneficial interests” in the trust. In Revenue Ruling 2004-86, the IRS held that, due to the very limited powers of the trustee, the owners of the beneficial DST interests are treated as grantors of a grantor trust, and for tax purposes own fractional interests in the underlying property held by the trust. 

Therefore, a beneficial interest in a DST that owns real property is equivalent to owning title in real property and is permitted to be a “like kind” property for purposes of completing a 1031 exchange. When investing in a DST, continuity of ownership is maintained and the beneficial interests in the DSTs are held by the same taxpayer who owned the relinquished (sold) property. 

Explore Your Options  

If you’re interested in learning more about utilizing trusts for a 1031 exchange, the team at First Guardian Group is here to help. Contact us today to schedule a consultation.

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Write to your Member of Congress and Senators urging them to oppose restricting Section 1031 like-kind exchanges. As part of the American Families Plan, the Biden Administration has proposed eliminating the application of Section 1031 for gains greater than $500,000. Like-kind exchanges have been part of the U.S. tax code since 1921 and are one of the tax code’s most powerful economic tools. It is critical that we all vigorously and visibly oppose this proposal. Make your voice heard with a pre-filled letter, which you can customize to add personal anecdotes or powerful client stories to highlight the positive impact of Section 1031 like-kind exchanges. Take action today by clicking HERE.

Paul Getty

Paul Getty is a licensed real estate broker in the state of California and Texas and has been directly involved in commercial transactions totaling over $3 billion on assets throughout the United States. His experience spans all major asset classes including retail, office, multifamily, and student, and senior housing. Paul’s transaction experience includes buy and sell side representation, sourcing and structuring of debt and equity, workouts, and asset and property management. He has worked closely with nationally prominent real estate brokerage and investment organizations including Marcus Millichap, CB Richard Ellis, JP Morgan, and Morgan Stanley among others on the firm’s numerous transactions. Paul also maintains a broad network of active buyers and sellers of commercial real estate including lenders, institutions, family office managers, and high net worth individuals. Prior to founding First Guardian Group/FGG1031, Paul was a founder and CEO of Venture Navigation, a boutique investment banking firm specializing in structuring equity investments made by institutions and high net worth individuals. He possesses over 35 years of comprehensive worldwide business management experience in environments ranging from early phase start-ups to multi-billion-dollar corporations. His track record includes participation in IPOs and successful M&A activity that has resulted in investor returns of over $700M. Paul holds an MBA in Finance from the University of Michigan, graduating with honors, and a Bachelor’s Degree in Chemistry from Wayne State University. Paul Getty holds Series 22, 62, and 63 securities licenses and is a registered financial representative with LightPath Capital Inc, member FINRA /SIPC. Paul is a noted speaker, author, and actively lectures on investments, sales, and management related topics. He is author of The 12 Magic Slides, Regulation A+: How the JOBS Act Creates Opportunities for Entrepreneurs and Investors, and Tax Deferral Strategies Utilizing the Delaware Statutory Trust (DST), available on Amazon and other retail outlets.

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