In order to meet the requirements of an I.R.C § 1031 exchange, the taxpayer who owns the relinquished property must be the same taxpayer who acquires the replacement property. “Continuity of investment” must be established by a fact pattern supporting the same taxpayer as both seller and buyer. As in most real property transactions, there are nuances. In this article, we will specifically review the role of Revocable and Irrevocable Trusts, and Land Trusts as they pertain to 1031 exchange and the same taxpayer requirement.
Disregarded Entities
In a 1031 exchange, an individual as the Exchangor can utilize a disregarded entity, such as a single member limited liability company (SMLLC) or a revocable living trust as the entity that acquires replacement property on their behalf. SMLLC’s and revocable living trusts are considered disregarded entities and the Exchangor will file a single return using their own tax identification number and not a separate EIN for the LLC or Trust. In doing so, the “Continuity of Investment” is upheld because the Exchangor is still considered the “same taxpayer” when utilizing a disregarded entity.
Trust Basics
Let’s review the basics principles of a Trust. Although there are many types of trusts with varying strategic benefits, we will focus on revocable and irrevocable living trusts and land
Revocable (Living) Trusts
Revocable (Living) Trusts (a type of “Grantor Trust”) constitute the most common type of Trust. Revocable Living Trusts do not file independent tax returns as all income, expenses, gains or losses are reported on the tax return of the Grantor of the trust. As you can determine from the name of the trust, at any time while the Grantor is living, the trust can be amended or revoked. Typically, the trustee, beneficiary(ies) and the grantor are all the same individual. This allows for the taxpayer to sell their relinquished property with the Trust on title and acquire their replacement property as an individual or a single member LLC or vice versa. A Revocable Living Trust is a helpful ownership vehicle in a 1031 exchange and can be utilized for additional privacy or to provide protection of the assets at the time of the Grantor’s death. In a 1031 Exchange where a Revocable Trust holds title, the Grantor or Trustee are considered the taxpayer. If the beneficiary is a different individual, they are not considered the taxpayer and therefore cannot benefit from a 1031 exchange directly.
Irrevocable Trusts
Irrevocable Trusts differ fundamentally from Revocable Trusts in that they cannot be modified or amended by the Grantor once they have been created. The Grantor has effectively removed all ownership rights to the assets once they’re held by the Trust. The primary difference for purposes of 1031 exchange treatment is that an Irrevocable Trust has its own separate tax identification number. Due to this unique attribute, an Exchangor who sells real property in an Irrevocable Trust must acquire replacement property in the same Irrevocable Trust to satisfy the same taxpayer requirement. An Irrevocable Trust is not a disregarded entity and therefore not eligible to be interchanged with a single member LLC or individual tax ID. Therefore, in a 1031 exchange, the Irrevocable Trust is considered the taxpayer.
Land Trusts
Land trusts created in Illinois, Indiana, North Dakota, Hawaii, California and Virginia are considered interests in real property and eligible for a 1031 tax deferral. Land trusts with multiple beneficiaries must follow certain rules to not be considered a partnership; primarily that no agreement between the taxpayer and beneficiaries exists that constitutes a partnership. Partnership interests are not 1031 eligible. Revenue Ruling 92-105, 1992-2 C.B. 204 provides that real property held by a land trust is not an interest in personal property or a beneficial interest in the trust. The land trust is an agreement where the trustee agrees to hold title for the benefit of the beneficiary.
The taxpayer is typically the beneficiary or a limited liability company who holds operational control, including tax payments, liability obligations and the sale of the real property. A trust land agreement is entered into between the trustee and real property owner (taxpayer) permitting a beneficial interest in the property. Public records show only the trustee and trust as the property owner while the trust taxpayer remains anonymous.
Land trusts are either revocable or irrevocable with the difference being that once the trust conveys the property to the beneficiary, no changes to the trust are permissible without the beneficiary’s approval.
We can help
Atlas 1031 Exchange has been accommodating tax deferred exchanges of all kinds for more than 16 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.
