Often the titleholder or taxpayer considering a 1031 exchange is a single or multi member limited liability company when selling real or personal property held in the productive use of a trade, business or for investment. For those new to the term “1031 exchange,” the IRS 1031 code allows the taxpayer to defer the federal and state capital gains and recaptured depreciation tax when selling and replacing of equal or greater value, real or personal property held for the proper intent. The 1031 exchange represents an interest free loan that can exceed 40 percent of the asset selling price, which would otherwise be paid to the Treasury Department.
Same Taxpayer
One of the many 1031 exchange rules is the same taxpayer requirement, stating that the taxpayer who sells is the taxpayer who buys. A limited liability company (LLC) is quite often the taxpayer on title. According to the U.S. Small Business Administration ,“a limited liability company is a hybrid type of legal structure that provides the limited liability features of a corporation and the tax efficiencies and operational flexibility of a partnership.” Owners are known as members. A single member LLC where the taxpayer is the only member is known as a sole or single member LLC. Profits and losses are passed through to the member and reported on the taxpayer’s federal return; consequently for federal income tax purposes the single member LLC is a disregarded entity.
Multi-member LLCs can also be formed where the members are individuals, corporations or other LLCs. Every state has a Limited Liability Company Act providing procedures to form and operate within its statutes. It is wise to consult with either your attorney or CPA when considering establishing a LLC to understand whether the formation of an LLC is to your benefit. Typically each state has a Department of State, Division of Corporations where Articles of Organization are created and annual reports submitted to maintain the LLC in good status. In Florida, www.sunbiz.org allows document searches to determine whether the LLC is active or not, as well as names of the members and address of the Registered Agent. Every state has a different fee to establish the LLC and file an annual report.
How do the following variations impact a 1031 exchange?
· Sole member
o A sole member LLC may sell or acquire the property in the individual’s name and vice versa.
· Husband and Wife
o A sole member LLC may sell and acquire the property as sole member LLC or individual and add spouse on to the replacement property deed as tenants in common.
o If husband and wife are on title selling property and reside in a community property state (Washington, Idaho, California, Nevada, Arizona, New Mexico, Texas, Louisiana and Wisconsin) one LLC can be established with the husband and wife as members to acquire the replacement property.
o If husband and wife are on title selling property and reside in a non-community property state and the intent is to title the replacement property in a LLC, then two LLCs are needed, one for the husband and one for the wife.
· Multi-member
o A two or multi member LLC owns a property and one member wants to cash out while the others want to defer the gain. Either the LLC is dissolved in a drop and swap, prior to entering the Purchase and Sale Agreement, dropping the members to their individual names as tenants in common as titleholders prior to the 1031 exchange or post exchange, or the LLC buys the cash desiring member out, known as “cross purchase,” with post exchange refinancing. The outgoing member is eliminated or reduced to a 1 percent member to maintain the LLC as a tax partnership.
Prior to establishing a LLC or a 1031 exchange, talking with your attorney or CPA is critical. If you own a property in a multi-member LLC, discuss with your partner their intentions to either cash out or to remain as members in the 1031 exchange. The earlier the steps are taken to drop and swap the better. Waiting just before the closing to decide jeopardizes the 1031 exchange given merit to the question whether the property is held for the proper intent by the new titleholders.
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Atlas 1031 has been accommodating all types of exchanges for over 16 years. Should you have any questions regarding 1031 exchange rules and requirements as it pertains to ownership, please contact us through the consultation on this page or call our office at 800-227-1031. We look forward to hearing from you.
