In a 1031 exchange, taxpayer “A” typically sells their relinquished property and receives the replacement property, and everything matches up identically. But sometimes taxpayers want to take title to the replacement property in a different fashion. Let’s talk about some of the different ways you can do that.
Form a Single Member LLC
One idea is to form a single member LLC that is wholly owned by taxpayer “A.” The new LLC (let’s call it NewCo) can purchase the replacement property and from the perspective of the IRS it’s still taxpayer “A” that’s receiving the replacement property through its ownership of NewCo. This is because NewCo is disregarded and seen as transparent by the IRS.
Revocable Living Trust
Another possibility is that a taxpayer may want to take title to the replacement property in a revocable living trust. A revocable living trust operates under the taxpayer’s social security number and for tax purposes it’s a disregarded entity – no different from the taxpayer. As long as they’re in a revocable trust and the grantor of that trust is the taxpayer, then taxpayer “A” could buy the replacement property as trustee of their own revocable trust.
Titling with your Spouse
Another option is that taxpayer “A” may want to bring their spouse (taxpayer “B”) into the replacement property as a co-owner. However, if taxpayer “A” alone owned the relinquished property that may create an inconsistency for tax purposes. If taxpayer “A” alone owned the relinquished property and taxpayer “A” and their spouse (taxpayer “B”) want to buy the replacement property there could be a dilution of taxpayer “A” equity so that they are deemed to only have received 50% of the replacement property and only used 50% of their exchange funds for their purchase…the rest could be treated as taxable boot given to taxpayer “B”. Questions to ask in this situation are:
- Was the relinquished property owned in a community property state and was the property considered to be owned by the two jointly?
- Are they in a non-community property state in which only taxpayer A is considered the sole owner?
I advise clients to take title to the replacement property without their non-titled spouse so they complete the exchange (exactly as they owned the relinquished property) and everything looks matching. Then at some point in the future they can make a new recording that includes their spouse on the title. In the interim they can provide for that titling inconsistency in their will or estate planning. Sometimes I have to provide marriage counseling in the process, because the non-titled spouse may feel uneasy about being kept off title for the new replacement property.