A NEW LOOK at who can do a 1031 exchange

I’m getting a lot of questions right now about who can do a 1031 exchange, so let’s take another look at the rules. Section 1031 says that the taxpayer is the one who sells the old property, buys the new property and reports the exchange. It sounds simple, but what does this mean?

First, we need to determine: who is the taxpayer? The taxpayer is the one who has reported the ownership of the property to the IRS. Don’t get hung up on the term payer – you don’t have to actually pay tax to be the taxpayer. If the property is held by an LLC, the LLC is the taxpayer even though it’s the individual LLC members (or owners) who pay the tax on the passed through income from the LLC. LLCs, partnerships, corporations and trusts can all do 1031 exchanges. This concept is especially important in those not uncommon situations where the reporting of the property to the IRS is different than the actual ownership of the property. For example, if Fred, George and Howie are equal tenant-in-common owners of a property, but they file an LLC tax return to report the income and expenses from the property, the LLC is the one who would have to do the exchange because it was the tax filer with the IRS.

Don’t get hung up on the term payer – you don’t have to actually pay tax to be the taxpayer . . . 

Fred could not take his share of the sale and do a 1031 exchange because he’s not the taxpayer; even though his name is on the deed. Think about it this way – if Fred did an exchange in this situation, and the IRS audited the exchange and asked to be shown where on his tax return Fred reported the income and expenses from the property, Fred couldn’t do so because the income and expenses were reported by the LLC even though the LLC wasn’t an actual owner of the property.

What if Fred, George and Howie did not file an LLC return, and actually did report the ownership as individual tenant’s-in-common? Who can do a 1031 exchange? Would they all have to do an exchange? Would they have to go together to buy the replacement property?

Again, you look to the taxpayer, and in this situation there are three taxpayers that own the property which means that each of the three guys can individually decide if they want to do an exchange and what replacement property they want to buy. For example, Fred can do an exchange and buy Property “A,” while George and Howie can each take their cash, pay the tax and not do an exchange. Or George could also do an exchange and buy Property “B,” while Howie takes his cash and pays the tax. Again, the IRS looks at each taxpayer separately to determine their ability to do, and their success at accomplishing, an exchange. And no, there is no problem with Fred selling his 33% share of the old property and buying a 100% share of Property “A.”

In summary, to determine who can do an exchange you first have to look at whose name and tax identification number (or social security number) is on the tax return that’s filed reporting the income and expenses from the property.

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