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While a 1031 exchange is often thought of as a way for investors to swap investment properties, it can also be a tool for owners of multiple property types to consolidate their holdings.
If you own a property that you would like to exchange for a single investment property, there are a few things you need to know in order to make sure the process goes smoothly. This guide will cover the basics of a 1031 exchange before delving into the specifics of completing this type of transaction with multiple owners.
What is a 1031 Exchange?
A 1031 exchange, also known as a like-kind exchange or a section 1031 exchange, is a way to defer paying capital gains taxes on the sale of an investment property by reinvesting the proceeds from the sale into another similar property. In order to qualify for this tax deferral, you must adhere to a few rules set forth by the IRS.
First, you must identify the property you wish to purchase within 45 days of selling your original property. This can be done by working with a qualified intermediary, who will hold onto the proceeds from your sale and facilitate the purchase of your new property.
Next, you must close on the purchase of your new property within 180 days of selling your original property or by the due date of your tax return (including extensions) for the year in which the sale occurred, whichever comes first.
Lastly, the properties you are exchanging must be “like-kind.” This means that they must be investment or business properties held for productive use in a trade or business or for investment purposes. Properties that are owner-occupied do not qualify.
Now that we’ve covered the basics of a 1031 exchange, let’s look at how you can use this tool to consolidate multiple properties.
Learn Some Common Scenarios
Some of the most common multiple owner scenarios include:
Husband and Wife
If both a husband and wife are owners of the property being sold, each must be added to the title of the new property purchased in the exchange. However, if only one spouse owns the property being exchanged, then only that spouse must be listed on the title of the new property.
Revocable Living Trust
A revocable living trust is often used to hold title to the property for estate planning purposes. If the property being exchanged is held in a revocable living trust, the new property must also be held in the same trust in order for the exchange to be valid.
If the taxpayer dies during the exchange period, the exchange is still valid as long as the new property is transferred to the decedent’s estate or heirs within 180 days of death.
All general partners must be listed on the title of the new property obtained in the exchange. Limited partners are not required to be listed on the title but may choose to do so.
C-Corporations, S-Corporations, and LLCs
The entity itself must be listed on the title of the new property obtained through the 1031 exchange. The shareholders or members of the LLC are not required to be named on the deed but may choose to do so.
With an understanding of how 1031 exchanges work with multiple owners in common scenarios, you’re ready to start the process of consolidating your holdings.
Get Started on Your Exchange
If you’re ready to get started on your exchange, the first step is to find a qualified intermediary. A qualified intermediary is a person or institution that acts as a go-between for the taxpayer and is responsible for holding the proceeds from the sale of the property and facilitating the purchase of the new property.
The intermediary must be independent of the taxpayer and cannot be related to them by blood, marriage, or business. Additionally, the intermediary cannot have provided any services to the taxpayer in relation to the property being exchanged.
What if the Property Owners Disagree?
It’s not uncommon for the owners of a property to disagree on whether or not to exchange their property. In these cases, the property can still be exchanged as long as all owner-participants sign a written agreement authorizing the exchange. This agreement should stipulate the terms of the exchange and outline what will happen if one of the owners decides not to participate or is unable to do so.
This is often referred to as the “drop and swap” method. Under this method, the non-participating owner is “dropped” from the title of the property and is released from any further obligation to the exchange. The remaining owner or owners can then continue with the exchange by finding another property to purchase.
It’s important to note that the “drop and swap” method can only be used if all property owners agree to it ahead of time. If even one owner objects, the whole exchange must be canceled.
The Bottom Line
A 1031 exchange can be valuable for investors looking to consolidate multiple properties. By following the rules set forth by the IRS and working with a qualified intermediary, you can ensure that your exchange goes smoothly.
If you need help completing your 1031 exchange, don’t hesitate to reach out to our team of dedicated professionals. We’re here to help you every step of the way.