Section 1.1031 of the Internal Revenue Code lets you defer capital gain taxes when you exchange like-kind properties that are held for investment or business use. To benefit from this, you need to follow several strict rules, one of which is the same taxpayer requirement. The taxpayer or exchanger can be an individual, a married couple, a trust, a partnership, a corporation, or a multi or single-member limited liability company (SMLLC). An exception to this rule involves what's known as a disregarded entity.
Understanding what a disregarded entity is requires knowing the basic rule for holding title to property. Essentially, the way you hold title to the old property must be the same way you hold title to the new property in a 1031 exchange. This means that the same tax return that sells the property must also be the one that acquires the new property.
THE EXCEPTIONS
There are four exceptions to the titleholder rule that introduce the concept of a disregarded entity. These entities hold legal title to property but don’t need to file income tax returns. They include land trusts, revocable living trusts, statutory trusts, and SMLLCs.
Land Trusts
Land trusts are used to keep the names of the actual property owners private. For example, if three people equally own a building valued at $400,000 through XYZ Land Trust, XYZ doesn’t file tax returns. Instead, each partner reports their share of the income and expenses on their individual tax returns.
Revocable Living Trusts
Revocable living trusts are often used in estate planning to avoid probate. Although these trusts hold title to the property, they don’t file tax returns. If you own property through a revocable living trust, the trust holds the title, but you report the property on your personal tax return.
This means you can take title to the new property in your name after selling the old one because it’s your personal tax return that owns both properties.
Statutory Trusts
Statutory trusts, like Delaware Statutory Trusts, combine elements of state land trusts and LLCs. With these trusts, property is titled in the name of the trust, but each member or beneficiary has a share of the property. Similar to LLCs, these trusts protect individual owners from liability.
Single Member Limited Liability Companies (SMLLCs)
In an SMLLC, the company is a disregarded entity because its taxes are passed through to the sole member, who reports them on their personal tax return. The net profit or loss of the SMLLC appears on Schedule C of the sole member’s Federal Form 1040, along with other income like interest and dividends.
You can even combine disregarded entities. For example, a Revocable Living Trust can be the sole member of an SMLLC. In this case, the titleholder is the Revocable Living Trust, and the individual whose estate is in the trust is recognized by the IRS as the taxpayer in a 1031 exchange.
How do you hold your property, and why?
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We Can Help
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From handling your transaction electronically to offering full encryption and timely updates, we ensure your exchange meets all IRS requirements. With offices nationwide, including Culver City, CA, and Fayetteville, GA, we’re here to support your investment goals with expert precision.
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