The 1031 exchange involves the exchange of relinquished real estate into replacement real estate, with the goal of potentially deferring taxes on capital gains. But rules need to be followed when completing a like-kind exchange to ensure that it’s valid to the IRS. One of these rules involves ownership of both the relinquished and replacement properties.
In answering the question about changing the title – or ownership – following a 1031 exchange, the general answer is “no.” The same investment entity must have ownership of the relinquished property, and take ownership (or the title) of the replacement property, or that exchange could be disallowed by the IRS.
However, as is the case in other tax issues, there can be some exceptions, like the following.
The Right Timing
If you decide you want to change title on a replacement property immediately after concluding a like-kind exchange, don’t. Remember that the replacement property is being held for trade or investment, and the IRS doesn’t look kindly on a sudden change in title.
If you absolutely must change ownership, the general rule of thumb is to hold the replacement property for one-to-two years before doing so. Otherwise, the IRS could disallow the exchange, and you could end up with an unexpected capital gains tax bill.
The Ownership Structure
If you have an LLC for your relinquished property, that same LLC needs to hold the title for the replacement property. You can’t change ownership to another LLC following the 1031 exchange. What you possibly can do, however, is to convert the replacement property’s ownership structure from an LLC to a tenant-in-common structure. But once again, don’t do this immediately following the exchange. Instead, wait for at least one to two years before considering such a move.
Trusts Considerations
It’s possible to put that replacement property into a revocable living trust or Delaware Statutory Trust and still follow the 1031 exchange rules. But that timing limitation still exists. It’s a good idea to not make this move immediately after the exchange.
Changing Titles: Caveat Owner
The IRS isn’t trying to put more red tape into a 1031 exchange situation by making ownership changes so complex. The rules are in place to ensure that the parties involved in a like-kind exchange aren’t trying to avoid tax liabilities.
As such, it is possible to make a title change following a 1031 exchange. But doing so can be complicated, requiring certain and specific steps. As such, if a title change is on your mind, be sure to check with a qualified tax consultant to determine your options.
This material is for general information and educational purposes only. Information is based on data gathered from what we believe are reliable sources. It is not guaranteed as to accuracy, does not purport to be complete and is not intended to be used as a primary basis for investment decisions. It should also not be construed as advice meeting the particular investment needs of any investor.
Realized does not provide tax or legal advice. This material is not a substitute for seeking the advice of a qualified professional for your individual situation.
Costs associated with a 1031 transaction may impact investor's returns and may outweigh the tax benefits. An unfavorable tax ruling may cancel deferral of capital gains and result in immediate tax liabilities.
