I need answers on details of a qualified 1031 Exchange. Looking for a QI that can answer this question:
1. Seller is a LLC (4 members/owners) .
2. Holding period of less than 1 year when sold.
3. How does each individual in the LLC qualify for a tax deferred exchange?
Are the proceeds divided based on percentage of ownership and then normal 1031 rules apply?
David Spencer, Broker and Licensed Instructor
David:
There are a number of questions that must be asked prior to giving you an answer. However, I will giv you an overview of the issues they need to address.
Currently, the LLC is the taxpaying entity that is contemplating the exchange. If the members plan on staying together in the LLC then it simplifies the situation. However, if the members want to split up and do invdividual things i.e. two want to exchange and two want to cash out, then there is substantial planning they need to do with their tax and legal advisors prior to closing the transaction.
1. Is there a current purchase contract for the sale in place?
2. What do the members want to do? Keep the LLC intact or go their separate ways?
If they plan on keeping the LLC intact, the primary issue for which they need to seek advice, is the holding period issue. Under the tax code, qualifying investment property for a 1031 exchange requires that at the time of acquisition the taxpayer intended to hold the property for productive use or investment use. The IRS has not given us a specific time period that they consider a "safe" holding period. However, one of the specific exceptions for qualifying property is property held for resale. The shorter the time the taxpayer has held the property the higher the risk that the IRS may (on audit) invalidate the exchange because they determined that the taxpayer intended to hold the property for resale as a opposed to investment. That's why it's so important to know exactly how long the LLC has owned the property.
If they want to split up the LLC and go their separate ways, they have two options.
1. Keep the LLC together, do the exchange and then either refinance and buy out the members who want to cash out or (they may purchase several replacement properties that are deeded to the individual members after some period of time.) This is typically called a "swap and drop." Do the exchange first then drop out of the exchange.
2. Distribute the asset to the members as tenant-in-common owners prior to sale and each individual member makes their own decision regarding the exchange. There is a risk that if the distribution occurs too closely to the close of the sale that they won't meet the "intention to hold" requirement for investment property. The farther in advance the distribution occurs the lower the risk. There are several federal cases favorable to the taxpayer on this issue. Each state has their own interpretation when it comes to collecting state capital gain tax. For example, the California Franchise Tax Board has taken a very strict approach with their mirror 1031 statute. This is typically called a "drop and swap."
Those are some basic issues in this type of situation. Please feel free to call me if you have additional questions or you want to give me specific details regarding the transaction. No matter what, the members will need to seek tax and legal advice regarding their particular situation to assist them in making decisions that are in their best interests.
It is also critical that they use a qualified intermediary that is experienced working with more complex transactions.
Lisa Lambert (559) 433-5399 or Asset Preservation, Inc.'s National Headquarters 1-800-282-1031 (8 am - 5 pm PST).
David:
Timely questions, I am looking at a similar situation. Thanks for the post.
Lisa:
Thanks for being a resource.
Alan:
Glad to be of help. It's a pretty fascinating area in 1031 exchanges. Feel free to contact me with any specific questions.
Lisa
you have 2 members of an LLC, the LLC is liquidated and the 1 piece of real property goes to one member and the other assets go to the other member.
immediately following liquidation, the member who received the real property enters into a like-kind-exchange. i realize the problem with the holding period, but this adds a twist because the real property was distributed to only 1 member.
to pass muster, couldn't one argue that if the other member is liquidated first, then the LLC turns into a single-member LLC, which is briefly owned by the 1 member who receives the real property. given the "same taxpayer" argument (that is, the short-lived single-member LLC is the same "being" as the sole member), it would seem that the taxpayer could argue that he could do the exchange either in his name or in the name of the "now single-member" llc?
thanks in advance for your thoughts.
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