In order to qualify for tax deferral under IRC Section 1031, the same taxpayer who owns and sells the relinquished property must be the same taxpayer who acquires the replacement property (emphasis that there must be continuity on both sides of the exchange).

Your go-to person in this scenario is your accountant or financial advisor, as they know how your taxes are filed and are in the best position to advise and confirm that this requirement is met. That being said, this article seeks to provide you with the preliminary information you may need to facilitate a productive conversation with your advisors. Kindly take note that as your qualified intermediary, Legal 1031 is unable to provide tax or legal advice and cannot make determinations for you regarding this requirement.

The same taxpayer rule governs how the relinquished and replacement properties are held on both sides of the exchange.

For example:

If the relinquished property title is held by 3 separate taxpayers:

• • • • • A Corporation
        • B Partnership
        • Jane Doe

Then replacement property title must be acquired by:

• • • • • A Corporation
        • B Partnership
        • Jane Doe

An exception to the above is where an entity is a disregarded entity (DRE). A “disregarded entity” is one that is disregarded or ignored for federal tax purposes. For example, a single-member LLC (SMLLC); unless elected otherwise per the IRS “check the box” regulations, the IRS disregards the LLC as an entity separate from its single member, and the member would report the LLC on their own tax return.[1] It is important to note that this tax classification generally does not affect the character of the entity for other legal purposes (i.e. limited liability and personal liability).

To illustrate this, if NY LLC (a single-member LLC) is selling title to the relinquished property, then NY LLC must be the same taxpayer acquiring the replacement property. However, if the exchanger wishes to add a friend to NY LLC before acquiring the replacement property, such an addition may change the LLC’s tax structure (creating a new tax partnership)[2], thereby invalidating the same taxpayer rule.

With the availability of a disregarded entity (DRE) to be utilized as a real estate holding company in a 1031 exchange, consider the following as an option to the above example:

If the relinquished property title is held by 3 separate taxpayers:

• • • • • A Corporation
        • B Partnership
        • Jane Doe

Then replacement property title must be acquired by:

• • • • • A Corporation (or a DRE, wholly owned by A Corporation)
        • B Partnership (or a DRE, wholly owned by B Partnership)
        • Jane Doe (or a DRE, wholly owned by Jane Doe, as an individual)

It should be noted that although ownership structures may change, it is still possible to maintain the tax identity. Of course, holding title in the taxpayer’s name individually is perhaps the most common form of ownership, however if properly structured, title may also be held in the following ways while still preserving the tax identity: as a single-member LLC, as a Tenant in Common (TIC), or under a Delaware Statutory trust (DST). Always be sure to consult with your tax or legal advisors to ensure that this requirement is met when considering a 1031 exchange.

To read about the same taxpayer requirement for spouses, check out our webpage here.

_________________________

[1] Per the IRS, “An LLC that is not automatically classified as a corporation and does not file Form 8832 will be classified, for federal tax purposes under the default rules . . . An LLC that has one member will be classified as a “disregarded entity.” A disregarded entity is one that is disregarded as an entity separate from its owner.” https://www.irs.gov/businesses/small-businesses-self-employed/limited-liability-company-possible-repercussions.

[2] “A partnership is the relationship between two or more people to do trade or business. Each person contributes money, property, labor or skill, and shares in the profits and losses of the business.” https://www.irs.gov/businesses/partnerships.

Legal 1031 Exchange Services LLC does not provide tax or legal advice, nor can we make any representations or warranties regarding the tax consequences of any transaction. Taxpayers must consult their tax and/or legal advisors for this information. Unless otherwise expressly indicated, any perceived federal tax advice contained in this article/communication, including attachments and enclosures, is not intended, or written to be used, and may not be used, for the purpose of (i) avoiding tax-related penalties under the Internal Revenue Code, or (ii) promoting, marketing, or recommending to another party any tax-related matters addressed herein.

© 2023 Legal 1031 Exchange Services LLC. All rights reserved. No rights claimed with respect to public domain and fair use materials contained or linked in this article.