By R.W. Bowlin
Co-ownership structure issues are one of the most common stumbling points for 1031 exchanges, however this need not be the case. With proper understanding and planning, most co-ownership structures can be worked through to satisfy the co-owner’s respective investment objectives.
One common situation we advise clients in is the exchange of property owned by either a partnership or LLC in which one or more of the partners/members intends to cash out their interest at the time of the transaction. Determining the appropriate exchange method to address this situation depends on the number of partners in the partnership. If there are three or more partners and the partners interested in exchanging their proceeds own, in aggregate, more than 50% of the partnership, then exchange methods in which the original partnership is preserved as an existing entity are possible. One possible method is for the partner who wishes to be cashed out of the partnership to receive a distribution of their partnership interest in the form of an undivided interest in the relinquished property in advance of the sale of the property, essentially creating a Tenant-In-Common ownership structure with two interests – the original partnership (less one partner) and the individual partner who wishes to receive cash proceeds from the upcoming sale of the property.
Due to the fact that an exchange can identify and close on multiple replacement properties, another approach arises. A partnership can exchange into multiple properties, then amend the partnership by-laws so that the majority of the rights of each respective property are allocated to each individual partner with the other partners taking minority positions in all properties except that which they are allocated the majority of.
Other approaches such as direct partner buy-outs and partnership divisions consistent with IRC §708(b)(2) are also possible before, during, or after an exchange.
Sole-owner LLCs in which the property is held by an LLC in order to gain liability protection are considered to be sole proprietorships for exchange purposes. A multi-member LLC that has not elected to be taxed as a corporation is considered to be a partnership for tax purposes and will be treated as such for exchanges as well, thus many of the entity restructuring techniques described earlier, as they relate to partnerships, are still possible and perhaps even easier within the context of a multi-member LLC.
Generally trusts fall in two overall categories, revocable and irrevocable. Trusts in which the grantor of the trust’s assets maintain their power of revocability through IRC §676 are considered to be “disregarded entities” for tax purposes, thus the grantor is considered to be the taxpayer exchanging the property. If the trust is irrevocable the trust itself is considered to be the taxpayer and any replacement property must in its entirety be owned by the same entity. Note, that trustee(s) are not considered to be the taxpayer(s) performing the exchange, regardless of whether the grantor is deceased or not.
While there are numerous other co-ownership structures, many of which are nuanced, rarely is an investor’s particular situation insurmountable. Do not hesitate to contact us if you have any questions regarding the specifics of your ownership structure when evaluating your options.
Roger W. Bowlin, President of Real Estate Transition Solutions, LLC, provides exit strategy analysis, execution and income and equity replacement options for investment property owners. If you have an issue or a concern relating to your investment property ownership, please email him at: RWBowlin@RE-Transition.com or call (206) 755-7068.
**This article was published in the April 2017 - RHAWA "Current" the monthly publication of the Washington Rental Housing Association.