If you perform 1031 exchanges, you must understand the same taxpayer rule. This rule mandates that the taxpayer who owns the relinquished property must be the same taxpayer who takes ownership of the replacement property.
If the taxpayer changes tax identities, then there would be no continuity of tax.
Bear in mind, however, that tax identity is not necessarily the specific name on the property.
Can a Taxpayer Change the Ownership but Preserve the Tax Identity?
Remember that we are talking about the tax identity, not necessarily the specific name on the title of the property. Below are some examples of the many ways in which a taxpayer can hold the title that would preserve the tax identity:
- In the taxpayer’s own name
- Under a single-member limited liability company (LLC) treated as a disregarded entity
- As the trustee of a Revocable Living Trust
- As a Tenant in Common (TIC)
- Under a Delaware Statutory Trust (DST)
- In a land trust in certain states
The Same Taxpayer Rule and Spouses
There are times when only one spouse is on the title to the relinquished property and the taxpayer wants to add the spouse to the title of the replacement property. This is not encouraged since the other spouse was not the same taxpayer who sold the relinquished property. Tax advisors and CPAs usually suggest waiting until the exchange is complete and a reasonable amount of time has passed to add a spouse to the title. Waiting several years should be sufficient.
Death of a Taxpayer during a 1031 Exchange
Unfortunately, sometimes a taxpayer passes away after the sale of the relinquished property, but before the purchase of replacement property. If the continuation of the exchange in these instances was not allowed, the estate is taxed on the gain from the sale. However, despite the fact that a deceased individual and his or her estate are not considered the same taxpayer, IRS regulations do allow the estate to continue the exchange transaction and receive tax deferral treatment.
The premise behind like-kind exchange tax deferral is based upon the continuity of a taxpayer’s investment. In addition, there is no question that if the taxpayer changes identities between the disposition of an asset and the acquisition of another asset, there cannot be a continuation of the taxpayer’s investment. However, there are various types of property-holding arrangements, many of which are disregarded for tax purposes, that allow a taxpayer to hold replacement property in a different name while meeting the same taxpayer requirement.
For more information regarding 1031 Exchanges, visit the Midland 1031 website or contact us at 239-333-1031.
For real estate investments within an IRA or other retirement account, contact Midland Trust at 239-333-1032 or visit www.midlandtrust.com.