Making changes to a property’s deed, also know as its vesting, before or during a 1031 exchange can be risky and may jeopardize the exchange’s validity. The “same taxpayer rule” dictates that the same individual or entity that relinquishes the old property must also acquire the new, like-kind property in the exchange to defer capital gains taxes. Any alteration to the property’s title can complicate this crucial requirement and potentially disqualify the exchange or create a tax consequence.
Why you should be wary of deed changes
Violating the “same taxpayer rule”: The fundamental principle of a 1031 exchange is that the same taxpayer who sells the relinquished property must be the one who purchases the replacement property. Changing the deed can change the identity of the taxpayer for tax purposes, leading to disqualification.
Triggering capital gains taxes: If the deed change is deemed to be a disposal of the property before the exchange is complete, it could trigger capital gains taxes on the original investment property, defeating the purpose of the 1031 exchange.
Adding or deleting a spouse: Adding or deleting a spouse from the title of the property can be problematic if it changes the taxpayer entity for tax purposes. For instance, if the property was held by only one spouse, but it is then placed into a joint tenancy with the other spouse, it could be seen as a change in ownership and jeopardize the exchange.
Community property states: In states with community property laws, both spouses are deemed to jointly own assets, regardless of how they’re titled. This might offer some flexibility, but it’s important to consult with a tax advisor as the exact enterpretation may vary.
General recommendations
Avoid changes whenever possible: Generally, it’s best to avoid any changes to the way the property is titled before or during a 1031 exchange.
Seek professional guidance: Consult with a tax advisor to discuss how any potential deed changes may affect the validity of your 1031 exchange.
Plan ahead: if a deed change is unavoidable, plan the timing carefully. It’s advisable to make adjustments well in advance of the exchange or postpone them until after the exchange is completed.