Note: You must set up an exchange prior to closing on a property. It is important to note that the following are scenarios that different taxpayer entities may encounter in regards to 1031 exchanges for LLCs.
A frequent strategy for acquiring and operating investment properties is by purchasing the asset through a partnership, commonly to maximize their purchasing power and reduce their risk liability. A general guideline for all partnerships and 1031 exchanges is that partnership interests cannot be exchanged. However, the Internal Revenue Service has clarified that a federal tax partnership does not include mere co-ownership of property where the owners’ activities are limited to keeping the property maintained, in repair, rented, or leased (Under 1.761-1(a) and 301.7701-1 through 301.7701-3). Thus, a partnership can perform a 1031 exchange if the partnership is the exchangor, however, exchanging partnership interests is strictly prohibited.
In this post, we are going to discuss different taxpayer/titleholder situations and possible scenarios these entities may encounter while trying to set up a 1031 exchange. It is important to note that the same taxpayer must acquire and hold title to the replacement property. If you are trying to determine the advantages and disadvantages of the different tax entities and their effect on your situation, it is recommended that you consult with your CPA or legal counsel.
Different Types Of Limited Liability Company Structure
There are two different types of Limited Liability Company structures. One is a Member-Managed LLC, and the other type is a Manager-Managed LLC. A Member-Managed LLC can have an individual or more than one member who is deemed as an authorized member who can make decisions, so before setting up a 1031 exchange, please refer to your operating agreement and see who would need to be involved in the process.
Single-Member Limited Liability Company
Both selling and purchasing property(s) within a single-member LLC should not raise issues, as you are keeping the same taxpayer consistent and continuing the ownership of real property. Before closing on a property, the Taxpayer, in this case, the single-member LLC, will set up a 1031 exchange through their Qualified Intermediary (QI). The individuals with signing authority of the LLC will sign the documents on behalf of the LLC. After closing on the relinquished property, the exchange proceeds will be sent to the qualified intermediary to be held in escrow and the 45 day identification period begins, running concurrently with the 180-day exchange completion deadline. When the authorized member of the LLC has identified a replacement property and has gone under contract for the new property, the QI will send the exchange proceeds to the closing company. The LLC will proceed to take title to the new property.
Multi-Member Limited Liability Company / Partnerships
Selling and purchasing properties via a Multi-Member LLC can be relatively straightforward if the members of the LLC agree to sell the property and set up a 1031 exchange. When all the members agree to enter the 1031 exchange (No members cash out, no members drop from the LLC or partnership agreement) then we can set up a 1031 exchange.
Before closing on a property, the Taxpayer, in this case, the multi-member LLC, will set up a 1031 exchange through their QI. After closing on the relinquished property, the exchange proceeds will be sent to the QI and the 45 day identification period begins, running concurrently with the 180-day exchange completion deadline. When the multi-member LLC has identified a replacement property and has a purchase-sale agreement in place for the new property, the QI will send the exchange proceeds to the closing company. The multi-member LLC will take title to the new property.
Issues with Multi-Member LLCs / Partnerships
Issues arise in a 1031 exchange when any of the following situations occur:
Members of the multi-member LLC want to cash out
Member or members do not want to participate in a 1031 exchange
Members want to exchange partnership interests
When a Multi-Member LLC holds title to a property, and some of the members wish to set up an exchange, and some of the members do not, there are a couple of options the multi-member LLC can attempt. However, these methods require advanced planning. It is recommended to speak with your CPA or legal counsel.
Please visit our website or call (239)-333-1031 to see if your investment, business, or rental property qualifies today.
Written by Alex Moore
Midland 1031 Associate, Midland IRA, Inc.