Tenancies

Joint Tenancy: In most instances this form of ownership is usually thought of as being held between married couples and there is one tax return filed on behalf of the couple. In the eyes of the IRS in regards to 1031 Exchanges, that one tax return owns the property.  This form of ownership does not require that the two people be married.  The important issue here is the tax return and who is actually entitled to do an Exchange.

In a training session hosted by Gary Gorman, the question was posed about how an Exchange would be handled if the married couple holding title as joint tenants filed separate tax returns.  He responded that the IRS views married people holding title as joint tenants.  The rule of the same people relinquishing the old property for the new property would still hold even if they were “married filing separate” returns.

Tenants-In-Common: We have discussed this form of ownership as it relates to additional opportunities to be used with 1031 Exchanges and as a stand-alone investment.  Here we are more focused on the way the IRS views the ownership, which is again traced to the tax returns filed by the parties involved.  There are multiple separate owners and because of this, there are a multitude of tax returns filed separately and apart from the property in most instances.  Therefore, if there is ownership of a large office building or shopping mall, the separate owners are filing individual tax returns based on their undivided interest and ownership of the property.  If an investor in such a venture were to sell his/her undivided interest and realize a gain, they would be able to relinquish their ownership interest in the old investment to purchase another property using the IRS Code Section 1031.  All other requirements for the Exchange must also be met under the Code.

Partnerships

Similar to the other forms of ownership, if the property to be relinquished is held in title by the partnership, then the purchase of new property under the IRS Code Section 1031 must be held in the same way.  Again, the IRS is looking at the tax return.  There are a couple of solutions that the partnership can do, especially if they want to go in separate directions.  One solution is to dissolve the partnership.  Each of the partners would give up their membership shares.  In return for the shares, each member would receive a deed for their undivided interest to the property being relinquished.  Each could then take their interest at closing and go their separate ways.  At this point, the property is now owned by multiple tax returns.  However, any partner that would continue to hold the property would have to wait the holding period of one year and one day before relinquishing the property and purchasing a new property.  The best way to do this is to dissolve the partnership and wait the holding period before repurchasing the new property to satisfy the IRS.

The other solution would be for the partnership to sell the old property and buy three replacement properties- one for each member of the partnership, assuming there are three members.  Each of the purchases would be in the name of the partnership.  The partnership could then hold the new properties for a year and a day, dissolve the partnership, and distribute the properties to the individual members.  The partnership agreement should be modified to the specific allocation of the profits and losses and positive and negative cash flow from each investment in respect to the partner that owns and operates the property during the year that the partnership still owned everything. The 1031 Exchange experts believe that the latter is the best solution.

Disregarded Entities

With anything, there are always exceptions to the rule.  This is also true for the IRS Tax Code Section 1031 and falls under the title of  “disregarded entities.” These include revocable living trusts, Illinois land trusts, and single member LLCs.  The exception is to the same ownership rule.  In fact, the ownership is really the same but the name is different.   

Revocable Living Trusts:  These are trusts that are set up to aid estate planning to help bypass probate in the case of death.  Most lenders will not lend to a trust.  However, the trust does not file a tax return.  The tax information is gathered from the owner of the trust before death, which would meet the requirements of the IRS where the owner is the entity that claimed the property.  The main issue is who filed the tax return and claimed the property. As long as the owner of the trust shows the owner as the entity that claimed the relinquished property and the tax return to purchase the new property are the same, the transactions should qualify for an exchange.

Illinois-Type Land Trusts: These trusts evolved from the fact that in the State of Illinois, all of the details of a real estate purchase and sale are reported in the local paper.  If the participants want to purchase property without the names of the parties being publicly announced they can purchase the property in the name of a trust.  Here again, the trust does not file a tax return.  All income and expenses are reported on the individual tax return. If the property is sold and one of the parties wants to take their share to purchase a new property, the IRS will allow this as an exchange if the party that claimed the proportionate share of the old property with expenses and income then purchases the new property.  It will be allowed in this case even if the title to the old and the new properties are different.

Single-Member LLCs: Limited Liability Companies (LLCs) are entities that combine the best attributes of both corporations and partnerships.  The IRS does not recognize one-partner partnerships.  They require that such a report of income and expenses be filed on a sole partner's income tax return.  In this case, the return is the individual tax return.  Therefore, even if the tax return is in the individual's name that claimed the old property, the LLC can purchase the new property because the tax returns are the same.  The LLC is the “disregarded entity.”

With all of this information, it is wise and strongly suggested that anyone attempting to use the IRS Tax Code Section 1031 and Tenant-In-Common opportunities first consult a CPA and/or legal counsel that is fully aware and informed on the specific requirements and qualifications of these transactions. Also, they should take great care in the selection and services of the Qualified Intermediary. Furthermore, in the State of Illinois under the Illinois Law of Descent and Distribution (Probate Act), if a person dies without a will, real estate located in Illinois held in the decedent's estate must go through probate proceedings.  It is wise to set up a will or utilize the benefits of setting up a trust to avoid the timely process and expense of probate. The focus for Invest With Passion! is to inform the industry that these opportunities exist and, if properly utilized, can indeed help investors build wealth through real estate - not only for their personal enjoyment, but also for their future generations.

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Crystal Harvey is a Real Estate Consultant for American Invsco, Realty and holds a Master of Science Degree in Real Estate.  She can be contacted at 312-595-4838 or Crystal.Harvey@AmericanInvsco.net.