Sometimes a couple will be doing a 1031 exchange where the relinquished property was owned by them as husband and wife, but they want to purchase the new replacement property with another family member as co-owners or tenants-in-common. In this article, we'll explain some key requirements to keep in mind while doing such an exchange.
1. Size Matters
In order to defer all of the gains, the ownership interest in the replacement property received by our exchanging husband and wife must be or equal or greater value than the net value of the sold relinquished property. So if a co-owning relative takes too large of a percentage ownership portion of the replacement property, our exchangors may not receive sufficient value to defer all of their gains.
2. Follow the Money
All of the exchange funds from the sale of the husband and wife’s sold relinquished property must be used exclusively for the purchase of their ownership interest in the replacement property, and may not be used to purchase the co-owning relative’s ownership interest. Each co-owner should contribute and pay for their proportionate share of the new replacement property with their own money.
3. Be Careful ~ Partnership Interests are Excluded from 1031
Once you own the new property, you may be tempted to file a partnership tax return (Form 1065) for the co-ownership of the property (like a joint venture). However, that would be inconsistent with the requirements for a 1031 exchange. Avoiding classification as a partnership for federal income tax purposes will be important for our exchangors to preserve their 1031 exchange. Generally, one cannot exchange into a partnership interest, even if partnership’s only asset is the subject real estate [subject to a narrow exception for partnerships with a valid 761(a) election in place; and rare situations where receipt of 100% of a partnership, results in consolidating ownership in one taxpayer such that it is equivalent to an acquisition of a "disregarded entity"].
- 1031 Hotline: If you have questions about replacement property rules, feel free to call me at 612-643-1031.
Defer the tax. Maximize your gain.
© 2017 Copyright Jeffrey R. Peterson All Rights Reserved