1031 Exchange From An LLC
I have read many post regarding this topic, but wanted to ask a specific question and for some advice.
I have several rentals and have a LLC. I haven't put the rentals in the LLC yet. My first question - Can you do a 1031 exchange from a LLC? if so are there any drawbacks?
Second question, Is there a time limit to hold investment properties before you can use them for 1031 exchange? I have a 4-plex I'm considering selling, but have owned for only 4 months. I got a great deal on the sale (60% FMV) and want to roll the equity into a larger investment.
My CPA is doing some research, but wanted to hear from the folks here too.
I am not a CPA or tax attorney, so you should always run your individual 1031 scenario by your tax advisor and a well versed qualified intermediary.
You can exchange from an LLC. One issue you may run into is if you own a partnership interest in the property - partnership interests are not considered "like-kind" to real estate for purposes of a 1031 exchange. So if you are a single member LLC you are OK. If you have partners and all of the partners want to exchange into the new property you should be OK. You will run into issues if you want to go different directions than your partners. If you each own an undivided interest in the property it is not the same as a aprtnership and you should be OK.
Regarding time limit, longer is safer. You need to hold it long enough to prove your intent was always to hold the property for business or investment purposes and not for the purpose of resale. This is because "inventory" is not eligible for 1031 exchange (such as builders selling spec homes). If your activities leading up to the purchase and while you have held the property show your intent has been to hold it for business or investment you have a better case to prove your intent. A common scenario is to hold the property for at least a year. It is also good if you show rental income from the property on at least one tax return. The level of risk you want to take on holding period and proving your intent is something only you can decide on. [ Edited by AJF on Date 05/27/2004 ]
Limited Liability Company
I gather from your post that you have set up a limited liability company (LLC) and you are the sole member of the LLC. In this case, you can absolutely contribute the property when ever you wish into the LLC and then do 1031 exchanges. A single member LLC is considered to be a "disregarded entity" for Federal income tax purposes so property held in the LLC is treated just like you owned the property in your name as an individual.
If you are married and both you and your spouse are members of the LLC, the LLC would still be considered to be a single member LLC and therefore a disregarded entity provided you live in a community property state and file a joint income tax return.
There are no draw backs from this scenario given the details that you have provided. The single member LLC is a great way to protect you from liability and still have the flexibility to do 1031 exchanges.
Corporations, Partnerships and multi-member LLCs create difficult issues for 1031 exchange transactions when the underlying investors want to go separate, individual ways.
Holding Period
The actual requirement that must be met in order for a transaction to qualify for 1031 exchange treatment is that the taxpayer/exchangor must have the INTENT to HOLD the property for rental or investment or use in a business. The Treasury Regulations are very clear that INTENT is very important, but they do not define how to demonstrate INTENT. This is where the amount of time for holding a property comes in. The easiest way to demonstrate your INTENT to hold a property for rental or investment is to do just that - HOLD it. The longer period of time that you HOLD it the better your case of proving that you intended to hold it. Most tax advisors recommend at least one (1) year.
Having said all of that, only the taxpayer/exchangor can determine how aggressive or conservative they want to be. The shorter the time frame for holding a property the more aggressive you are positioning yourself, and the longer the time for holding a property the more conservative you are being. A double closing or an immediate flip clearly does not qualify and the only reason the one poster above has been able to maintain those transactions is that he/she has not been audited specifically on their 1031 exchange reporting.
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Bill Exeter
[ Edited by wexeter on Date 05/27/2004 ]
[ Edited by wexeter on Date 05/27/2004 ][ Edited by wexeter on Date 05/27/2004 ]
Bill and AJF,
I really appreciate the insight. I have set up the LCC with my wife and we make decisions jointly. I orginally intended to hold this piece of property like I have with my other properties, however after owning it for a few months I now see other properties I would like buy using the substantial equity I have in this property. The property has great cashflow, but we are going through a bit of "growing pains" since I had to fix it up and get all new tenants, this got me thinking about reselling. I will hold it for at least 6 month (pre-paid issues), hopefully all the growing pains will be cleared and I can hold for atleast a full year. Again thanks for the info.
My CPA (who has several rental properties) and my title company (who does 1031 exchanges) both say that the intent or holding period is irrelivant. I had always heard about intent, but they both suggested that I 1031 a townhome that I owned for only 2 months. In fact they were both very surprised at my questioning a 1031 when I had only owned the property for a short time.
Brenda
Thanks Brenda,
I sorta figured that "intent" is hard to prove either way. I guess it comes down to how comfortable I feel doing it. I have a meeting with my CPA next week to work out the details.
Brenda,
I would be VERY careful in what your CPA and your title company are telling you. You can read the Treasury Regulations and MANY Court Decisions for yourself and you will see that INTENT is very important and is discussed indepth. I have been doing 1031 exchange transactions since 1986, and have administered in excess of 50,000 for my clients (I run a large qualified intermediary/accommodator company) and I can assure you that INTENT does play an important role. I also know from many years of experience that Accommodators do not like to talk about intent because they might talk the client out of doing a 1031 exchange and therefore lose a fee. However, the right thing to do is talk about intent and do what is right by the client. I also know that most CPAs really do not understand the detailed technical issues involved in a 1031 exchange because they are not involved with it day-by-day. There is a lot of bad advice out there and it is Exchangor/Taxpayer Beware. I would strongly urge caution here.
I have posted a brief article on Holding Requirements for 1031 Exchange Property tonight.
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Bill Exeter[ Edited by JohnLocke on Date 06/19/2004 ]
Bill, I've been thinking the same thing about the fact that QI's are essentially on a comission basis...
Do they have any liability?
Bill,
Can't wait to read the article. I'm having a little problem with my account at TCI (won't let me access the articles - LOL) I should get it resolved this week. Like I stated earlier, my "intenet was always to hold, but after some difficult issues i got to thinking about selling. I want to make sure that I do everything by the books.
Someone asked about accommodator liability. You should look for an accommodator who has both bonding and errors and omissions insurance. It also helps to work with an accommodator company that has staff persons that are also licensed members of a licensed profession - such as a CPA, attorney, etc. They have to abide by the rules of the licensed profession to stay licensed there. The longer the accommodator has been in business and the more exchanges they have done, the better. For more information, check with the exchange industry's professional organization - The Federation of Exchange Accommodators. They have a website, but I don't think they let you post URLs here. If you do a search for their association name you'll find their site. I would prefer to use soemone who has invested in a memebrship in their own professional organization. To me it seems this whould show they are trying to make sure they are doing things properly.[ Edited by AJF on Date 06/10/2004 ]
The liability issue has yet to be put to the test in this particular issue. However, every set of 1031 Exchange Agreements, documents, and hold harmless language that I have reviewed always insists that the taxpayer/investor must review his or her own transaction with his or her own tax advisor and that the QI has no liability except for their own gross negligence.
The insurance protection that you should look for to protect yourself in this situation is the E&O (errors and omissions insurance). Many QIs can not afford E&O insurance or can not obtain it.
[addsig]
The article on Holding Requirements has not been posted yet, so you can view it at http://www.diversifiedexchange.com/property_holding_period.asp or call me and I'll email you a copy of it.
[addsig]
Quote:Bill, I've been thinking the same thing about the fact that QI's are essentially on a comission basis...thestudentisready,
My exchange agent works for a flat fee of $750. We are direct deeding, so the exchange agent is never on title for either of the exchange properties. Maybe this has a bearing on his fee structure.
My exchange agreement has a "hold harmless" clause.
NewKidinTown,
I think the liability they were referring to was liability as far as giving tax advice or guidance on how to structure a transaction. This is why the E&O insurance coverage is so important.
Does your QI pay you interest on your exchange funds? It is rare that a QI ONLY charges a set-up fee of $750.00 and nothing more. I would suspect that they also share in the interest earned on the account.
[addsig]
Bill,
My accomodator is really only functioning as an escrow exchange agent for a flat fee.
Escrow funds will be invested in short term instruments to generate taxable income. I will be the beneficiary of the income earned by the escrow funds. The exchange agent will deduct his fee from the exchange funds prior to disbursement to the settlement agent for my replacement property. Hopefully, the income earned by the escrow funds will be enough to cover the fee, otherwise, the escrow funds will make up any shortfall.
The exchange agent is the trust department at my bank.