Does a 1031 Exchange Need to Be in the Same Name?

When we discuss the specific provisions governing the execution of a 1031 exchange, sometimes we neglect to mention that the reason the IRS allows this transaction is in recognition of the ongoing nature of the investment. This fact is worth considering since the IRS created some rules to test that status. For example, the deadlines for identifying the replacement property and consummating the acquisition can demonstrate that the taxpayer is traveling down a path rather than completing one investment and engaging in another. Similarly, the limitation on eligibility to “like-kind” investments is a testament to the ongoing endeavor. The IRS further upholds this condition by requiring the taxpayer's identity to remain the same.

How does a 1031 exchange work?

If an investor wants to sell an investment property to reinvest the proceeds into another investment property, they may seek to do so by employing a 1031 exchange transaction. Using the 1031 may allow the investor to defer the payment of capital gains and depreciation recapture taxes on the sale of the original property as long as they satisfy the IRS' conditions.

The IRS levied capital gains taxes on the difference between the investor's basis (purchase price plus certain expenses) and the sale price. If the investor holds the asset for less than a year, the capital gain is deemed short-term and taxed at the same rate as ordinary income. However, if the investor owned the property for more than a year, the increase is long-term and subject to tax at the lower, long-term capital gains rate. Consider this example:

Joe buys a multifamily housing unit for $500,000 and owns it for five years. He then decides that he would prefer to focus on self-storage facilities and sells the apartment complex for $900,000, resulting in a long-term capital gain of $400,000. If Joe pays the capital gains tax on that $400,000, he might pay as much as $80,000 (plus any depreciation that needs to be recaptured), which will constrain his reinvestment options. If Joe conducts a 1031 exchange to reinvest the funds, he must reinvest the entire proceeds, not just the gain, and the purchase price for the replacement property must be equal to or greater than the sales price of the relinquished asset.

Joe has 45 days following the sale of the original (relinquished) property to formally identify potential replacements using one of these three options:

1. Identify up to three possible replacements, with no limit on total value.
2. Identify any number of potential replacements as long as the aggregate value is not more than 200% of the sale price of the original property.
3. Identify any number of potential replacements with no value limit, but Joe must then purchase 95 percent of the total value identified.

Regardless of the replacement property option used, the acquisition must be completed within 180 days of the original sale to demonstrate the investment's ongoing nature. Joe can continue using the 1031 exchange transaction to sustain the deferral. However, if at some point he executes a sale with no qualifying exchange, he would need to pay all accrued taxes and depreciation recapture then. Alternatively, Joe can continue using the 1031 exchange until he distributes the asset to an heir on a stepped-up basis.

Are there exceptions to the same-name requirement?

Since the issue is not the actual name but rather the taxpayer identity, there are some workarounds and carveouts regarding the name. For example, the asset may be owned by an LLC that is treated as a disregarded entity and qualify as “same taxpayer.” Similarly, the owner can be the trustee of a Revocable Living Trust or a Delaware Statutory Trust (DST).

Also, in most cases, if a taxpayer dies during the completion of a 1031 exchange, the IRS will allow the estate to continue the transaction, despite the taxpayer and the estate being distinct taxpaying entities. The bottom line is that the taxpayer may not change identities, but various holding options may satisfy the requirement.