To complete a 1031 exchange on property held in an LLC or Partnership, the property must be taken out of the LLC and held as tenants-in-common. See my notes below and call with questions. 949 307 2616 [email protected]
1031 Drop & Swap Information – Notes for Investors
The issue arises when an investment property seller holding partial ownership in a LLC wishes to do a 1031 exchange. That seller must put the title back in her name in order to complete the exchange.
The partnership interest in an LLC is considered personal property—and therefore an owner cannot exchange an LLC membership interest for another LLC membership interest.
If this investor is the sole owner of the LLC, she can go ahead an exchange—no issues.
In an LLC held property, the investor who sold the Relinquished Property and deferred the gain from the sale must be the same taxpayer entity that purchases the Replacement Property (Whoever sells the down-leg must be the buyer of the up-leg.)
Tenant-in-Common, or TIC ownership is considered individual ownership in RE and is separately respected. So, each tenant-in-common (TIC) is a separate entity.
Two partners, A & B, when “B” wants to sell;
1) Deed the LLC interests to TIC. (multiple parties directly on title.)
2) Sell the property.
3) Distribute equity.
4) Partner “B” takes equity and pays taxes.
5) Partner “A” 1031s into an up-leg property.
Issues – Partner “B” does not have drop-and-swap issues, but merely has to pay capital gains and recaptured depreciation.
Partner “A” needs to show the IRS that he held the property for “Investment Purposes.” One idea is to covert LLC to TIC as soon as possible and keep running the entity.
Single-member LLCs are “disregarded entities” for tax purposes. (there is no difference between the LLC and the one member who owns that LLC)
(one attorney’s opinion) – There is no bright-line rule for how long assets must be held. Two years is considered safe, two months might be risky.
Partnership interests are not permitted to do separate 1031 transactions. (must be the entire entity).
When you convert interests into TIC, you must deed the property to each member in the same proportion as shown in the LLC.
The IRS added Form 1065, Schedule B to the tax code in 2008. It asks; “at any time during the tax year, did the partnership distribute to any partner TIC, or other undivided interest in partnership property.”
“Held For” requirement – This is a timing issue. The Code requires that the property must be held for
A) investment or B) for productive use in business or trade to be eligible for a 1031 exchange.
The Tax Code does not specify how long property must be held in order to be considered “being held for investment purposes.” IRS and Case Law is unclear on timing of holding period.
IRS has lost numerous cases against tax payers. They are not as aggressive as the Franchise Tax Board (FTB)
The FTB has taken the position that they are not bound by Federal decisions.
The Same Taxpayer Rule—Any entity can do a 1031 at the entity level.