After the column was published, we heard from several readers. Here is an edited sample of their comments and questions:
Comment: When a limited liability company in which each member is a 50 percent owner is selling a jointly owned property, both members must agree and participate in the sale of the property and use the 1031 exchange together. They must both sell and then must both buy a replacement property using the 1031 mechanism.
Often, though, partners have different views on what to do with the sale and what to do with the proceeds from the sale. One may want to continue in real estate and the other may want to liquidate and start making estate planning arrangements. However, if the LLC is disbanded and broken up into separate partnerships roughly nine to 12 months before a sale, then each partner can use a 1031 exchange if they wish, or take the cash, pay their taxes and make the grandchildren happy.
Our response: You’re right. When a property is owned in a corporation, limited liability company or other entity, the selling entity must contemplate the sale, the use of a 1031 exchange and intermediary and the purchase of a replacement property. For a 1031 exchange to work, the seller of the old property must be the same as the buyer of the replacement property. In this example, the owner of the old property was the LLC and not the LLC’s members. If the LLC wants to sell the property, it can; and it can then buy a replacement property.
In many situations, partners and co-owners have differing views of what the future holds. As you stated, the partners, owners or members can change the ownership structure well before the sale to allow one of the owners to continue with real estate ownership while the others do something different. Working with a 1031 exchange specialist a year or two before a sale will go a long way to helping all the owners.
Remember, when it comes to 1031 exchanges, the owner of the current property must be the owner of the replacement property. So, if a company owns a piece of property, sells it and opens a 1031 exchange, the replacement property must be purchased by that same company. There are certain exceptions, but you need to work closely with your intermediary to make sure that the exception applies to your transaction.
Comment: The questioner said he recently sold a condo. If he sold and collected the proceeds, wouldn't that eliminate the possibility of a 1031 exchange, as it requires a qualified intermediary to help in the exchange process? That point should have been clarified before the rest of the answer, or at least mentioned in the article.
Most people don’t differentiate between “sold” and “closed,” and I read it to mean that the condo sale was complete.
Our response: Yes, if the seller had signed a contract and had not closed on the sale, the seller still can complete a 1031 exchange. However, as you rightly noted, if you have closed on the sale of the property and have the cash from the sale in hand, you’re out of luck and can’t then try to start a like-kind exchange.
Q: Can you use a four-unit rental property as an item that would be exchanged with a large real estate investment trust on the stock exchange?
A: There are some ways of investing in REITs, but not the way you might think. These investments generally involve Delaware Statutory Trusts and probably are not the REITs you’re looking at in a newspaper or stock exchange.
You can place a call to some of the larger national companies that act as 1031 exchange intermediaries and they can walk you through the process.
If you’re looking to exchange your four-unit rental property for a real estate investment that requires you to be less involved with the day-to-day management of the investment, you can buy into a property (or group of properties) that are managed by a TIC, which stands for tenant in common.
Here’s how they work: A company that specializes in TICs will sell you a fraction of an investment in a project, development or building where you will own a percentage. The TIC takes care of the project, development or building and they take care of everything you need (and you’ll get whatever revenue is generated after payment of management and other fees); and you will be an owner alongside other owners.
It’s a less active real estate investment but it should work for a 1031 exchange. Just be aware you’re not anonymous because you own a piece of the underlying real estate in the TIC. With a Delaware statutory trust, you wouldn’t own the real estate but instead would be the beneficiary of a trust that owns the real estate.
Both TICs and Delaware Statutory Trusts are more complicated legal instruments, and you should work with a knowledgeable attorney and accountant who can help you understand the details and how they’ll affect your finances.
Keep in mind that you can't sell your ownership in real estate and exchange that for stock in a company or a membership interest in a limited liability company.
Ilyce Glink is the author of “100 Questions Every First-Time Home Buyer Should Ask” (4th Edition). She is also the CEO of Best Money Moves, an app that employers provide to employees to measure and dial down financial stress. Samuel J. Tamkin is a Chicago-based real estate attorney. Contact Ilyce and Sam through her website, ThinkGlink.com.