The 1031 Exchange process can be rewarding, but intimidating, for the uninitiated. The intimidation factor is created by the vague wording of the Internal Revenue Code (IRC) 1031 and the somewhat inconsistent case law interpreting that code. Sound advice from knowledgeable professionals and prudent action by the investor can mitigate most 1031 Exchange issues and provide a way – even for novices – to take advantage of this powerful tool.
One common issue that jeopardizes a lawful exchange has to do with ownership. As indicated in the blog post titled Six Requirements for a 1031 Exchange, the taxpayer of the old (relinquished) property must be the same taxpayer for the new (replacement) property. But who is the taxpayer exactly? How the exchange is titled is very important, but it is not the definitive test for compliance with IRC 1031. The inexperienced believe that the title of the replacement property must mirror the title of the relinquished property, and that it is the only way to determine who “owns” the property. However, the IRS actually looks at how tax returns are filed for both properties to determine if the taxpayer(s) remained the same.
The Exchange Resource Group recently performed an exchange for a client who wanted to sell a piece of property titled in her name. For financing purposes, the bank required that she and her husband be on the title of the replacement property, but she had been advised that doing so would jeopardize her exchange. After researching the situation, ERG determined that the original property had come to her through her deceased husband’s estate over a decade ago. For the prior nine years, it had been correctly filed on Schedule E of her joint tax return with her new husband. So who was the taxpayer? She and her husband were the taxpayers as joint tenants as evidenced by their tax filings. Under IRC 1031, the change in title to joint ownership with her husband in this instance was a valid action within the exchange.
Investors looking to use 1031 Exchanges as a long term investment strategy will want to be conscious of how the property is titled and reported for tax purposes prior to the initiation of any exchange. Possible holding structures include individual, corporate, partnerships, LLCs, trusts or tenancies. Each of these holding structures may be impacted differently by the exchange and may tempt the uninitiated to alter ownership on the relinquished or replacement properties. It is of particular importance to seek the expert counsel of your investment accountant and attorney as you make these ownership and exchange decisions.
While IRC 1031 spells out many aspects of a lawful exchange, it is often case law that provides guidance for the unique situations and circumstances investors face. It is the very challenge of finding ways for investors to take advantage of this tax deferral opportunity that makes ERG passionate about its services. ERG is committed to finding solutions for investors that capitalize on their opportunity to utilize 1031 Exchanges.