Can You Change Ownership in a 1031 Exchange?

Real estate investors who wish to defer capital gains taxes from the sale of investment properties by completing a 1031 exchange have a lot of rules and regulations to follow throughout the exchange process.

One of the most important aspects of completing a 1031 exchange and enjoying the beneficial tax treatment is the same taxpayer requirement – the same taxpayer has to divest the relinquished property and purchase the replacement asset in the exchange. However, there may be some instances when a change of ownership can occur in properties involved in a 1031 exchange without voiding the exchange. Let’s take a look at those scenarios, as well as provide some insight into prospective timelines if you plan on changing ownership of your replacement property.

1031 Exchange Same Taxpayer Requirements

The Internal Revenue Service affords capital gains tax deferral to real property owners who roll over the entirety of sale proceeds from one investment property into a like-kind replacement property. If the taxpayer changes at any time during or immediately after the 1031 exchange, there’s no reason for the IRS to afford tax deferral to either taxpayer.

Additionally, exchange regulations are clear regarding the transfer of ownership of the properties being swapped in a 1031 exchange. The taxpayer who transfers title to a buyer of the relinquished asset must also be the taxpayer who receives title on the replacement property. If there’s any change, then the same taxpayer isn’t disposing of and receiving title to each property and the exchange will be nullified. Taxpayers leave a paper trail to follow from one property to the next by relinquishing the old title and taking possession of the new title, which provides an ironclad safe harbor for their exchanges.

Any change of ownership soon after the exchange has been completed will also likely void the exchange as well and result in generating a capital gains tax liability from the sale of the original investment property. If you eventually plan on transferring title to an exchanged property out of your name, it’s best to wait until your exchange is “old and cold.” Waiting several years and letting some dust collect on your file after your exchange is finalized before changing ownership can help avoid any potential conflicts of ownership with the properties involved in your exchange.

Potential Changes in Ownership for 1031 Exchange Properties

There are a few scenarios where a change of ownership may not void your 1031 exchange.

• Community Property. If you live in a state with community property laws, but there’s only one spouse on the title of an exchanged property, then both spouses are still deemed to jointly own the asset regardless of how it’s titled. Two exceptions to this rule are if the spouse received the real estate as a gift or as part of an inheritance. There are only nine states that have community property laws.
• Death of the Taxpayer During the Exchange. If the taxpayer dies while the exchange is in progress, IRS regulations do allow for a decedent’s estate to receive tax deferral despite the fact that an estate and a dead person aren’t one and the same.
• Exchanging into a Delaware Statutory Trust. Investors can complete 1031 exchanges by purchasing beneficial interests in Delaware Statutory Trusts in the exact amounts needed to satisfy exchange requirements. Although investors are purchasing beneficial interests in a trust rather than holding title to real property, they still can enjoy tax deferral provided it’s the same taxpayer.

Putting it all Together

The 1031 exchange process has many stipulations that must be followed exactly. The IRS affords capital gains tax deferral to investors who sell and purchase investment properties without ever receiving any sale proceeds.

In rare instances, investors can change ownership of exchanged properties without voiding their exchanges. However, most of the time, the replacement properties involved in 1031 exchanges shouldn’t change hands until the exchange is years old and the regulatory spotlight is shining elsewhere.