Yes, an irrevocable trust can do a 1031 exchange under certain circumstances.
A trust is when a benefactor, or grantor, designates a third party, called a trustee, to manage their assets. The two main types common in real estate are revocable trusts and irrevocable trusts.
The major difference between the two is how to change the terms of the trust. The grantor can change a revocable trust at any time. Conversely, the grantor cannot modify an irrevocable trust once they establish it.
There are also different tax implications. In a revocable trust, property and assets still belong to the grantor, and they are liable for paying income tax. A separate tax return is not filed.
In an irrevocable trust, the grantor gives up all rights to the assets. The trust files Income taxes, and they report all earnings and tax liabilities using a tax identification number (EIN) assigned to the trust.
It is possible for both types of trusts to facilitate a 1031 exchange. Here, we will discuss how an irrevocable trust can do a 1031 exchange.
How Does An Irrevocable Trust Work?
There are three key parties involved in an irrevocable trust:
- Grantor: holder of assets that sets up the trust.
- Trustee: legally responsible for managing the trust.
- Beneficiary: the recipient(s) of the trust.
An irrevocable trust, as mentioned above, files income taxes on behalf of the trust and has a unique IRS EIN number.
Real estate held in an irrevocable trust is legally titled to the trustee, or the holder of the trust. The beneficiary holds the equitable title, depending on the terms of the trust.
Because the ownership of assets is permanently transferred to the trust, the grantor is not responsible for tax liabilities created by the assets. This is one attractive benefit of an irrevocable trust.
How Does An Irrevocable Trust Do A 1031 Exchange?
For assets held in real estate, it is common for properties to be put in a trust. Properties in a trust can be used as investments and qualify as a 1031 exchange. The rules are generally the same as a basic 1031 exchange.
In a 1031 exchange:
- The replacement property must be of equal or greater value than the relinquished property.
- The property cannot be used as a personal residence of the taxpayer.
- The replacement property must be identified within 45-days of relinquishing the original investment.
- The exchange needs to be completed within 180 days.
The caveat with a trust is that a 1031 exchange must be completed by the taxpayer, who in this case is the irrevocable trust. So, when an irrevocable trust facilitates a 1031 exchange, the relinquished and replacement properties must be sold and purchased within the same trust.
On the other hand, in a revocable trust, the taxpayer is the grantor, and so the 1031 would be done through them.
