In this article, we are going to discuss a few ways to reconfigure an LLC that is taxed as a partnership to allow one or more of the members to conduct 1031 exchanges.
Jettison the Other Guy Out of the LLC
In this scenario, you split the real property into two parts. The exchange minded owner(s) keeps the old LLC, and the non-exchange minded owner is moved into a new LLC. For example 25% of the real property is retained by the old LLC, and 75% of the real property is transferred to the new LLC. Split the 1099-S for tax reporting. This allows the exchange minded owner to do an exchange, and the other guy to take his money and pay the taxes.
Partnership Installment Note (PIN) Solution
You could also split up by buying out the non-exchange minded owner interest in the LLC with an installment note. After the sale closing is complete the QI gets in 25% of the net proceeds directly in the exchange minded owner’s separate, segregated 1031escrow account; and 75% of the sale proceeds is received by the QI in another different account, and is then used by the QI to pay off 90% of the installment note in the current year, and the remaining 10% (plus interest due) in the subsequent year.
Keep the Old LLC Intact and Complete the 1031 AND Split up LLC Down the Road
Fully defer the gain and complete the 1031 at the LLC level with all members remaining in the entity. After the dust has settled on the 1031, split up the LLC and distribute out the UPREIT shares to the owners – Later each owner could sell portions of the UPREIT in small allotments to stay under the preferential tax rates (when retired).
Partnership Division 708 Spin Off
A 708 spin-off would allow both owners to do separate exchanges. A 708 spin-off is when an LLC that is taxed as a partnership divides into two or more partnerships/limited liability company [§708(b)(2)], and each is considered to be a continuation of the predecessor entity so that the holding period or qualified purposes requirement is met by all entities. Each entity has the same partners as owners, but the ratio of ownership in each entity is skewed/weighted to benefit one partner.
Crude, Simple Drop and Swap
A drop and swap exchange allows real estate owners to "drop" their ownership structure out of an "entity level" to a co-ownership as tenants-in-common (deed out real property from the entity to the individuals) – turning former partners into tenants in common in the underlying real property. When the property is sold, the proceeds are divided proportionally, and co-owners can now either cash out and pay their taxes or reinvest into another investment property through a qualified intermediary (QI) and still defer taxes. This method has some significant issues regarding holding periods and qualified use requirements for a 1031. PRO TIP: Get the banks consent to the change in ownership if there is a mortgage on the relinquished property; and refrain from acting like a partnership or de facto partnership.
Start Your 1031 Exchange: If you have questions about 1031 exchanges, feel free to call me at 612-643-1031.
Defer the tax. Maximize your gain.
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