Real Estate Matters: An expanded conversation about like-kind exchanges
A few weeks, ago, we wrote about like-kind exchanges (also known as an Internal Revenue Code Section 1031 exchange) and the temporary relief being granted to some buyers and sellers during the COVID-19 pandemic.
For those of you who missed the column, a like-kind exchange is where an owner of an investment piece of property decides to sell it, use a qualified intermediary and then buy a replacement property within a relatively short period of time. For their effort in using the 1031 mechanisms, the owners of the sold property are allowed to defer paying federal income and recapture taxes to the IRS. There are strict timing restrictions and other rules you must abide by, and you should talk to a person that specializes in 1031 exchanges to make sure this is would be helpful to you financially.
After the column was published, we heard from a number of readers. Here is an edited sample of their comments and questions:
Comment: Just wanted to drop you a note in case you write another article on 1031 exchanges. When selling a jointly owned property, say a limited liability company (LLC) where each member is a 50% owner in the LLC, both members must agree and participate in the sale of the property and use the 1031 exchange together. They must both sell and then must both buy a replacement property using the 1031 mechanism.
Often, though, two partners have different views on what to do with the sale and what to do with the proceeds from the sale. One may want to continue in real estate and the other may want to liquidate and start making estate planning arrangements. However, If the LLC is disbanded, broken up into two separate partnerships, roughly nine to 12 months before a sale, then each partner can use a 1031 exchange, if they wish, or take the cash, pay their taxes and make the grandchildren happy.
Our response: You’re right on this one. When a property is owned in a corporation, limited liability company (LLC) or other entity, the selling entity must contemplate the sale, the use of a 1031 exchange and intermediary and the purchase of a replacement property. For a 1031 exchange to work, the seller of the old property must be the same as the buyer of the replacement property. In this particular example, the owner of the old property was the LLC and not the LLC’s members. So, if the LLC wants to sell the property, it can; and it can then buy a replacement property.
In many situations, partners and co-owners have differing views of what the future holds. And, as you stated, if you plan ahead, the partners, owners or members can change the ownership structure well before the sale to allow one of the owners to continue on with real estate ownership while the others do something different. Again, planning well in advance and working with a 1031 exchange specialist a year or two before a sale will go a long way to helping all the owners with their needs and desires.
Remember, when it comes to 1031 exchanges, the owner of the current property must be the owner of the new replacement property. So, if a company owns a piece of property, sells it and opens up a 1031 exchange, the replacement property must be purchased by that same company. There are certain exceptions, but you need to work closely with your intermediary to make sure that the exception applies to your transaction.
Comment: Saw your article about 1031 exchanges in Sunday’s real estate section of our paper. Did you overlook the elephant in the room? The questioner said he recently sold a condo. If he sold and collected the proceeds, wouldn’t that eliminate the possibility of a1031 exchange, as it requires a qualified intermediary to help in the exchange process? That point should have been clarified before the rest of the answer, or at least mentioned in the article.
The question stated that (s)he had “recently sold a condo…” Most people don’t differentiate between “sold” and “closed,” and I read it to mean that the condo sale was complete.