Can an LLC or Trust Do a 1031 Exchange? Can an LLC or Trust Do a 1031 Exchange?
Working with a Qualified Intermediary like Leader1031 to complete a 1031 exchange using Section 1031 of the U.S. Tax Code is a great way for real estate investors to defer capital gains tax on property transactions. 1031 exchanges are great way for investors to create a path to potential wealth building by deferring capital gains taxes through the sale of an investment property and purchase of a like-kind replacement property (or properties).
Since real estate investments are commonly held by Limited Liability Company (LLCs) or Trusts in addition to individual investors, a common question is whether these types of entities can also take advantage of the benefits of a 1031 exchange in property transactions. Below we'll explore whether both single-member and multi-member LLC can perform 1031 exchanges as well as whether different types of Trusts can do the same.
Key Takeaways
- Single-member LLCs can perform 1031 exchanges
- Multi-member LLCs can perform 1031 exchanges, although the process is more complicated if all members and managers of the LLC are not aligned
- Both revocable (living) trusts and irrevocable trusts can initiate 1031 exchanges
- The first step to take for LLCs and trusts looking to complete a 1031 exchange is to contact a Qualified Intermediary
Can a Single-Member LLC Do a 1031 Exchange?
A single-member LLC is usually able to perform a 1031 exchange. Generally, LLCs are formed so that the owner (or owners) are not personally liable for the actions of the business entity and the personal assets and liabilities of the owner(s) are separate from those of the actual business. LLC's are "pass-through" entities which essentially means that any profits may be passed to the owner(s) of the entity without the owner(s) having to pay taxes on earnings a second time upon receipt from the entity.
What does all of this mean when it comes to completing a 1031 exchange? If an LLC is owned by a single individual (member), then they'll be able to complete a 1031 exchange and defer capital gains tax by selling one property and purchasing a like-kind replacement property -- Treasury regulations stipulate that a single-member LLC is treated as what's called a "disregarded entity" for tax purposes, meaning that the entity is not taxed as a separate entity from the owner for federal tax purposes.
Can a Multi-Member LLC Do a 1031 Exchange? What is a Drop and Swap 1031 Exchange?
Completing a 1031 exchange with an LLC that is owned by multiple members is slightly more complicated than completing one with a single-member LLC -- especially if some members want to initiate a 1031 exchange and some want to cash out of the business. Interests in the LLC are not considered like-kind property and so capital gains taxes on their sale cannot be deferred through a 1031 exchange.
If all members who own interest in the LLC and the LLC’s managers choose to participate in a 1031 exchange by selling property owned by the LLC and purchasing like-kind property, then they may defer capital gains taxes from the sale. If a majority of the members of an LLC want to initiate a 1031 exchange while the others do not, then the LLC can do what is called a drop and swap 1031 exchange where the member(s) who do not wish to participate in the exchange transfer their ownership interest in the LLC to the LLC in exchange for an equivalent percentage of the replacement property. This allows the members who are not participating in the exchange to become separate taxpayers from the LLC and receive some proceeds from the sale. However, the members who do not participate in the exchange will pay capital gains taxes on sale while the other members who have the LLC’s proceeds go to a Qualified Intermediary will enter an exchange and defer the LLC’s portion of capital gains taxes on the sale.
Can a Trust Perform a 1031 Exchange?
There are many different forms and styles of trust. Two distinct forms of trust are revocable trusts and irrevocable trusts. A revocable trust can be amended or revoked at any time by the grantor while the grantor remains living. Living trusts are a form of revocable trust where typically one or two people are the grantors, trustees, and beneficiaries of the trust during their lifetime. These living trusts are often disregarded entities, which as mentioned above means that the trust is not taxed as a separate entity from the grantor. This allows a taxpayer to sell a property held by the trust and purchase a like-kind replacement property in their own individual capacity or even as another disregarded entity, such as a single-member LLC or another trust. It's important to note that these rules only apply to certain forms of trust and if the trust is not considered a disregarded entity, then the trust must purchase the replacement property.
You can probably guess from the name, but an irrevocable trust cannot be revoked by the grantor once they have been established. In creating an irrevocable trust, the grantor is giving up ownership to any assets held by the trust -- including real estate. Irrevocable trusts are not disregarded entities, have their own tax identification number, and file separate tax returns from the grantor. When it comes to 1031 exchanges, an irrevocable trust may exchange property owned by the trust but the trust must acquire any like-kind replacement property.
How Real Estate Investors Can Get Started with a 1031 Exchange
The first step investors should take when exploring the benefits of a 1031 exchange is to ensure they have surrounded themselves with the appropriate team of professionals to guide them through the process, including a tax advisor, realtor, attorney, and Qualified Intermediary.
Finding the right Qualified Intermediary to work with is crucial to the 1031 exchange process because it helps verify the security of your funds and provides your entire team with knowledge and experience that they might not otherwise have.
Your Qualified Intermediary will interact with your realtor, tax advisor, escrow professional, attorney, and representatives for the property you are purchasing, so it's extremely important to make sure you choose a QI who can guide your team through the complexities of the process while meeting all of the important associated deadlines.
Leader Bank's 1031 exchange subsidiary, Leader1031*, serves as a Qualified Intermediary for real estate investors seeking to sell and purchase property using the tax-deferred advantages of a 1031 exchange. These services provide greater integration and efficiencies for our commercial real estate clients, and Leader1031 is committed to providing the highest quality of service.
As soon as your relinquished property has gone into contract, you can set up a 1031 Exchange account with Leader1031. This 1031 Exchange account and certain documentation provided by your QI must be in place prior to the close of your relinquished property sale.
Leader1031 is ready to help ensure your transactions are in full compliance with IRS Code Section 1031. Contact Leader1031 today.
It is imperative that you also consult with your own tax and legal counsel. Leader1031 is prohibited from providing tax and legal counsel as a qualified intermediary under the IRS Code Section 1031.
The content of this publication is provided as general information only and should not be taken as legal, investment or other professional advice. This content of this publication shall not be construed as a recommendation to participate in any particular trading, financial or investment strategy, and neither Leader Bank, NA nor Leader1031.com, LLC can provide legal or tax advice concerning the specific tax consequences of a given transaction. Any action that you take as a result of information or opinions provided in this publication is ultimately your responsibility. Consult your attorney, accountant, or tax professional before making any investment or financial decisions.
To ensure compliance with requirements under Treasury Department Circular 230, we inform you that the contents of this publication are not intended or written to be used, and may not be used, for the purpose of (i) avoiding U.S. federal tax penalties or (ii) promoting, marketing, or recommending to another party any matter addressed herein. Each taxpayer should seek advice based on the taxpayer’s particular circumstances from an independent tax adviser.
