Sometimes a property seller is interested in contributing a portion of his or her real estate into the project as equity, but also wants to take some cash out for a 1031 exchange. Here's a strategy to accomplish that.
721 Tax-Free Contributions
One way to structure the sale agreement is to have the taxpayer (seller) enter into two agreements with the buyer — typically an LLC taxed as a partnership.
- First, the taxpayer agrees to sell to the LLC an undivided X percent of the property for cash that will be assigned to a qualified intermediary for a 1031 tax-deferred exchange.
- Second, the taxpayer agrees to contribute the remainder of his or her interest in the property to the same LLC in a 721 tax-fee contribution in exchange of a partnership interest (LLC membership interest).
By splitting the transfers in two and doing the 1031 sale first, the taxpayer is able to get the most tax efficient treatment on both transfers.
There are some potential complications if the LLC distributes cash to the members after the contribution, so you need to be careful when taking-out construction financing. Here are some issues to consider:
- What amount of debt — if any — encumbers the property at this time?
- What is the seller’s current adjusted basis in the property? (check for “MOB” mortgage over basis)
- What is the cash price allocated for the sale portion of the transaction?
- What is the value or amount of the LLC/partnership interest being given in exchange for the contribution or the remainder of the property?
Having a qualified intermediary on your side to tackle these issues can ensure the most tax-efficient strategy possible.
- 1031 Hotline: If you have questions about the 1031 exchanges combined with 721 contributions, feel free to call me at 612-643-1031.
Defer the tax. MAXIMIZE your gain.
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