Many people want to complete their 1031 exchanges by purchasing property in a disregarded entity or entities. In a 1031 exchange the “same taxpayer” needs to complete the purchase of the replacement property, but that taxpayer can do that by acquiring the property through a disregarded entity.
What is a Disregarded Entity?
A Disregarded Entity (DRE) is a business entity that the IRS does not consider separate from its owner for federal income tax purposes. This means that the income, deductions, and credits of the DRE are reported on the owner's personal tax return.
What about the Community Property Exception?
In community property states, a business entity that is wholly owned by both spouses can also be treated as a disregarded entity. Key points include:
The entity must be considered community property under applicable state laws.
The entity must not elect to be treated as a corporation for tax purposes.
This generally applies only if the spouses file a joint tax return and reside in a community property state.
State Law Considerations
While a disregarded entity does not exist separately from its owner for federal tax purposes, it is still recognized as a legal entity under state law. This means:
The entity maintains limited liability protection, meaning its owners typically aren’t personally liable for the entity’s debts and obligations.
A disregarded entity may have separate legal standing, which can provide business liability protections.
In summary, disregarded entities offer a simplified tax reporting structure for single-owner businesses while still providing some legal protections under state law. Taxpayers looking to complete exchanges may want to use disregarded entities to protect themselves or to compartmentalize liabilities.
The Many Benefits of Like-Kind Exchanges Under Section 1031
Section 1031 of the Internal Revenue Code offers numerous benefits that many taxpayers are unaware of. The most important benefit is that of tax deferral. 1031 exchanges are also known as “tax-deferred” exchanges because they allow you to defer your capital gains tax burden on the sale of qualifying like-kind property. However, in order to reap the benefits of tax deferral, you need to make sure you meet certain requirements. A qualified intermediary can help advise you on your best options and make sure you are aware of all the requirements of section 1031. Contact CPEC1031 today for more information.
Start Your 1031 Exchange: If you have questions about 1031 exchanges, feel free to call me at 612-643-1031.
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