1031 Exchange Strategy for Selling Condo's
I get this question at least a few times each month and thought the question and one suggested structure would be of help or interest to others.
The Question:
A taxpayer has purchased a 30 unit condominium complex about one year ago. If the individual units were sold separately, the period over which the closings would take place would be uncertain, perhaps a year or so. Under what circumstances would a 1031 exchange be possible?
One Solution or Possible Structure:
The first issue that the taxpayer and thier tax advisor should look into is whether the taxpayer would be classified as a dealer in real estate. If so, dealers do not qualify for 1031 exchange treatment. If you close on 30 individual sale transactions over a 12 to 24 month period you will probably be classified as a dealer and not be able to structure your transactions as 1031 exchanges. Should the taxpayer and their tax advisor decide that it would qualify for 1031 exchange treatment, I would open separate 1031 exchange files for each individual condominium so that you would have a separate 45 day and 180 day period for each transaction.
I do have a thought, however, that may help the taxpayer qualify for 1031 exchange treatment. It gets a little complex, but we have used this structure with other clients in the past. It would involve setting up another legal entity such as an LLC or C Corporation, of which the taxpayer would own less than a 10% interest. You would then sell the entire Condominium property to the new entity, as one property/one transaction for 90% to 95% of the expected fair market value. This way the taxpayer can structure his or her sale as a 1031 exchange transaction and purchase replacement property that they want, have the new entity do the individual sales and the new investors would have a somewhat built in gain of 5% to 10%, depending on how much they purchase the property for and what the market does.
This structure could also be used for vacant land where the taxpayer intends to develop. Sell the land to the new entity at 90% to 95% of the expected fair market value after development, and then the new entity could do the build out and sell the individual homes or units.
Just an advanced planning thought for a difficult 1031 exchange issue. There are many tax issues involved, so each taxpayer should always seek their own tax and legal counsel prior to attempting any structure like this.
Have a great week.
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Quote:It would involve setting up another legal entity such as an LLC or C Corporation, of which the taxpayer would own less than a 10% interest. You would then sell the entire Condominium property to the new entity, as one property/one transaction for 90% to 95% of the expected fair market value.Bill,
How does the investor who receives a 10% interest in the new corporation avoid cash boot from this 1031 transaction?
It appears that the investor receives 100% of FMV for the property as follows: 90% FMV in cash, and 10% as shares in the corporation.
If this is the case,wouldn't the 10% interest in the corporation be cash boot from the 1031 transaction, and,
didn't the 10% instant equity for the other investors just evaporate?I am sure there are more details to this deal that are not intuitively obvious. Would you plese fill in the blanks? [ Edited by DaveT on Date 06/15/2003 ]
No, because the investor has sold 100% of his/her interest in the property (the relinquished property) to the corporation and then completed his/her 1031 exchange transaction by acquiring a replacement property. The corporation is a separate taxpaying entity and is not a related party or a controlled entity and has merely acquired the taxpayer's relinquished property. Once the corporation completes the development and sells the property the actual capital gain resulting from the sale would be taxable to the corporation/taxpayer, but this is a separate transaction and has nothing to do with the 1031 exchange.
It is a fairly complex and aggressive tax planning structure that we use with some of our more sophisticated clientele.
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