Have an LLC membership interest in an entity that owns real property? If so, the need to structure your ownership is critical in being able to take advantage of a 1031 exchange.

Generally when an interest in real property is sold a tax payer is required to pay taxes on any capital gains at the time of sale. However, Section 1031 of the Internal Revenue Code allows for the deferral of the payment of taxes on the capital gains if a taxpayer reinvests the proceeds from the sale in a replacement property(ies) pursuant to the Code and guidelines provided by the Internal Revenue Service – what is commonly known as a 1031 exchange.

1031 exchanges are not available for LLC membership interests. With this in mind, here are some ways your ownership can be restructured to allow for 1031 treatment.

STRUCTURE OWNERSHIP ACCORDINGLY

1031 Exchanges are not available for LLC membership interests, which are treated as partnership interests, which are expressly excluded from 1031 treatment.

In order to preserve the opportunity to participate in a 1031 exchange, buyers may want to structure ownership accordingly. For example, you may consider structuring as tenants in common instead of as members of an LLC. In this effort, you should determine long-and-medium-term goals to structure ownership accordingly in order to preserve the right to engage in a 1031 exchange at some point in the future.

MEETING REQUIREMENTS

Even if ownership is structured as tenants in common, certain requirements must be met or the taxing authority may deem the ownership a de facto partnership. This is important to keep in mind as partnerships are excluded from 1031 treatment.

To assure that your ownership is structured in a way that is included in the 1031 treatment, you should structure the tenant in common relationship with the enumerated guidelines outlined in Revenue Procedure 2002-22. This is critical as holding title as tenants in common is just one factor the taxing authority looks at to verify that the ownership is in fact a tenancy in common, with TIC interests amendable to 1031 treatment.

RESTRUCTURING AN LLC TO ALLOW 1031 TREATMENT

Even if ownership is held in an LLC, ownership can be restructured to allow for 1031 treatment. Sometimes long-and-medium-term goals change, or circumstances prevent the appropriate structure at acquisition, but the situation can be remedied. 

The key here is to restructure as early as possible and to observe appropriate tenant in common requirements subsequently. The standard holding of a property interest subject to 1031 treatment of two years pre-exchange is preferred, or at a minimum acquisition occurring in one tax year and the exchange occurring no earlier than the following tax year. This is important to do in order to maximize the potential that the 1031 exchange will not be challenged by the taxing authority, or if challenged, will be approved.

CONCLUSION

Although the 1031 exchange is not available for LLC membership interests there are ways to restructure to implement its advantages.

Our attorney team can help by structuring and restructuring ownership to maximize the potential of successfully participating in a 1031 exchange. If you have questions regarding your LLC and are considering restructuring your ownership, give us a call.