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Archive for February, 2008

1031 Exchange and Single Member LLC’s

February 15, 2008

FACTS:Taxpayer [TP] is a single-member, single-asset LLC.TP has relinquished property under contract to sell and replacement property under contract to buy.Net equity in relinquished property = $400k; $500k in net equity is required to acquire replacement property.TP wants to bring investor with $100k into ownership of replacement property.What is the most clearly defensible method to accomplish TP’s goal?Do defensible alternatives exist?ANSWER: See http://www.blackacre1031.com/rules.htmSection 1031 of the I.R.C. has many quaint rules and requirements, as do many areas of the law. The two and one-half primary rules controlling my contribution to this discussion are:(1) The same Taxpayer (“TP”) that sells must be the same Taxpayer that buys – the <Same Taxpayer> Rule; and,(2) In order to be completely tax deferred, Taxpayer must Trade Up or Trade Even in their debt and Trade Up or Trade Even in their equity – less allowable exchange expenses; the < Trade Up or Trade Even> Rule.(3) Really (2A) a corollary of Rule 2, above, if TP wants less overall debt on the Replacement Property than TP had on the Relinquished Property, TP can substitute new, outside cash for debt. Therefore, TP can take cash from their Home Equity Line of Credit or from their Schwab or Fidelity account or from spare change in one of TPs purses in the back of the closet to substitute new cash for the debt – as long as it is cash with respect to this transaction.What constitutes meeting the <Same Taxpayer> Rule when the Taxpayer owns Relinquished Property inside Taxpayer’s Single Member LLC that is a disregarded entity for Federal Tax purposes?At the Federal tax level, obviously a Single Member LLC that is a disregarded entity for Federal Tax purposes is disregarded for Federal tax purposes. This occurs when the TP does not <check the box> to be taxed as a corporation. On these facts, the Taxpayer is not the LLC, but the Taxpayer. Simple, yes?In this case, with respect to a Section 1031 Exchange, the Taxpayer can own and sell the Relinquished Property (“RQ”) inside Robert1 LLC, a Single Member LLC that is a disregarded entity for Federal Tax purposes and buy the Replacement Property (“RP”) inside Robert2 LLC, a Single Member blah blah blah, etc…. N.B. the RQ is 1600 Pennsylvania Avenue, Washington, DC.Therefore, as long as the TP meets the Trade Up or Trade Even rule by spending all of TPs equity on the RP and either walks their debt, gets new debt that is equal to or greater than the debt that was on the RQ, or adds new cash to the extent that they do not meet the debt amount that was on the RQ, TP can identify and acquire an 80% undivided Tenant-in-Common ownership in the RP, while New Investor, who is a co-owner and not a partner, acquires a 20% TIC interest. N.B. On TPs Notice of Identification, TP would identify an 80% TIC interest in Arrowhead Stadium in KC, which I have chosen as the RP for my example, certainly a trade up.If both TP and New Investor were doing exchanges and both identified simply Arrowhead Stadium, it is implied that they mean 100% of Arrowhead Stadium. Since one is acquiring 80% and the other is acquiring 20%, neither acquired what they identified – 100% of Arrowhead Stadium. If you don’t acquire what you have identified, you don’t have a good exchange. The Regs (in conjunction with the courts) have given a little bit of flexibility here. In fact the rule is that if you don’t acquire SUBSTANTIALLY what you have identified, you don’t have a good exchange. That cutoff is at 75%. So if they both identified Arrowhead Stadium, TP who acquires 80% of Arrowhead Stadium will have a good exchange…but if you can help it, don’t do it that way. The law gives you some leeway, and if you know you are acquiring 80% I heartily encourage you to have your client identify 80%.I do agree with other writings on this thread in the past couple of days. New Investor should not be brought into the entity if the entity is disregarded. New Investor does not need to be brought into the entity at all. Taxpayer can also use their same LLC to acquire their RP and TP does not need to switch to a new entity.Last note: Be sure that formalities of co-ownership are established in writing and followed so that the ownership form can withstand charges by the IRS that the arrangement is really a partnership and not a co-ownership TIC arrangement. But that is for another thread another day. In the meantime, if I can be of any further assistance, my full-time business is acting as Qualified Intermediary in Section 1031 Tax Deferred Exchanges and I would be delighted to be at your service.Cheers,Robertwww.blackacre1031.com
Robert M. Levenson, Esquire
BlackAcre 1031 Exchange Services LLC
2 Wisconsin Circle, Suite 700
(240) 235-5022
(202) 494-2700 mobile
1+(301) 542-0003 fax – preferred
(240) 235-5023
Robert@BlackAcre1031.com