Section 1.1031 of the Internal Revenue Code provides for the deferral of capital gain taxes. This is granted in exchange of like property that is being held as an investment or for productive use in a trade or business. There are many rules that must be stricly followed including one known as the same taxpayer requirement. The taxpayer or exchangor can be an individual, husband and wife, trust, partnership, corporation, multi or single member limited liability company (SMLLC). The exception is known as a disregarded entity.
To understand what a disregarded entity is, it is important to understand the basic rule for holding title to property. The rule is that the way one holds their title to the old property is the way one has to take title in the new property in a 1031 exchange. This means that the tax return that sells is the tax return that acquires.
The Exceptions
There are four exceptions or variations to the titleholder rule and it is these that bring into play what the Internal Revenue Service (IRS) refers to as a disregarded entity. These are entities that have legal title property but that aren’t required to file income tax returns. They are land trusts, revocable living trusts, Statutory Trusts and SMLLCs.
Land Trusts
These are a disregarded entity title holding vehicle that are set up to conceal the names of actual owners from the public. Say, for instance, three people are equal owners or beneficiaries of a building known as XYZ Land Trust worth $400,000. XYS is not required to file income tax returns but each partner reports their share of income and expenses on their individual income tax returns.
Revocable Living Trusts
A revocable living trust is used as a disregarded entity in estate planning to prevent probate. The trusts do hold title to property but no file tax returns are done. If a property owner held property in a Revocable Living Trust, the trust has title to the property. However, on the owner’s income tax return, the owner rather than the trust owns the property. The owner can take the title to the new property purchased after sale of the old one instead of having to take title in the name of the Revocable Living Trust. This is because it was the owner’s personal tax return that owned the old and the new property.
Statutory Trusts
A third type of disregarded entity is the Statutory Trust. These are also state specific so you may come across for instance, Delaware Statutory Trust. Statutory Trusts bring together the best of state land trusts and Limited Liability Companies or LLCs.
With this type of disregarded entity, property owners hold a title to property in the name of a Statutory Trust but every member or beneficiary is taken to be have a share of the property. Like LLCs, the Trusts keep individual owners protected from liability.
Single Member Limited Liability Companies
In a SMLLC, the SMLLC is considered a disregarded entity or pass through for the reason that the taxes of the SMLLC are passed through to the sole member to report on their personal tax return. The net profit or loss of the SMLLC is reported on Schedule C of the sole member’s Federal Form 1040 tax return along with other forms of income such as interest and dividends.
It is possible and it is in fact a strategy that is utilized is to combine more than one disregarded entity. This would mean the sole member of a SMLLC is a Revocable Living Trust. The titleholder is the Revocable Living Trust and the individual whose estate is placed into the Revocable Living Trust is recognized by the IRS in a 1031 exchange as the ultimate taxpayer.
How do you hold your property and why?
To learn more about when 1031 exchanges, download the free “Ten Reasons Why a 1031 Exchange Makes Sense” by clicking here.
We Can Help
Atlas 1031 Exchange has been accommodating tax-deferred exchanges of all kinds for more than 17 years. We are fluent in the rules and regulations of IRC Section 1031 and able to help you navigate your exchange.
Contact us today to discuss any questions you may have. Call our office at 1-800-227-1031, email us at info@atlas1031.com, or submit your question through the online form at the top of this page.
