In order to satisfy a successful 1031 exchange, the taxpayer must remain the same from the relinquished property to the purchase property. However, business considerations, liability issues, and lender requirements may make it difficult for the exchanger to keep the same vesting on the Replacement Property. Exchangers must anticipate these vesting issues as part of their advanced planning for the exchange.
There are some exceptions to this rule when dealing with entities that are disregarded for federal income tax purposes. The following examples of changes in vesting will usually not jeopardize the integrity of the exchange:
Revocable Trust
Nancy owns a rental property held in her revocable trust in which she is the sole trustee. She has been filing the annual taxes using her Social Security Number (SSN) as her Tax Identification Number. She goes forward with a 1031 exchange by selling her property. But when it comes time to purchase a replacement property, she runs into a potential issue with the bank she is trying to get financing from. Nancy is notified by the lender that her loan approval is contingent on her taking title in just her name as they will not lend to a trust. She is worried that this will compromise her exchange, but the good news is that the integrity of her exchange is fine because she is still maintaining the same underlying taxpayer from the sale to the purchase. When filing taxes for her revocable trust, Nancy filed under her SSN. Likewise, when she files in her individual capacity, she will continue filing under her SSN. The IRS is satisfied because the same taxpayer that began the exchange also completes the exchange. Therefore, Nancy can move forward with taking title to the purchase in her name and obtaining the financing she needs to successfully complete her exchange.
Single-Member LLC
Bill sells an apartment building he has owned for many years with the title held solely in his name. The transaction goes smoothly and the net proceeds come into the exchange. During his 45 day period, Bill finds a potential replacement property and decides he wants to purchase it within his LLC. Since he is the sole member of the LLC which is treated as a disregarded entity for federal tax purposes, he is permitted to move forward with the change in vesting. He has fulfilled the same taxpayer requirement imposed by the IRS.
Disregarded entities for federal tax purposes, like a single-member LLC, file taxes under the single-members SSN. Therefore, when an exchanger shifts from an LLC to an individual, or vice-versa, the same taxpayer is maintained.
Vesting issues can pose many pitfalls for an exchanger. It is best to consult your legal and/or tax adviser in properly structuring your 1031 exchange. For further help please feel free to call us.
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