"THE RULE"

While there is not a requirement specifically stated in IRC Sec. 1031 or the accompanying Regulations, a basic rule for Exchangers is that there must be continuity of title in the qualifying properties and this is particularly significant with regard to real property and personal property whose ownership evidenced by a certificate of title. This is commonly referred to in the 1031 Exchange industry as the "same taxpayer rule". It means that title to the Replacement Property in an Exchange must be ultimately acquired in the same name of the same party (as reflected on the tax return) as the party or entity holding title to the Relinquished Property. As with any rule there are always exceptions.

EXCEPTION TO RULE - DISREGARDED ENTITIES

A significant exception to the general rule described above arises when the transferor of the Relinquished Property or the transferee of the Replacement Property is a "disregarded entity" or the "owner" of a disregarded entity. A disregarded entity is an entity that holds legal title to property but is not required to file an income tax return. The entity is treated by the IRS as if it does not exist and the owner and the entity are, in effect, one and the same.

There are four basic disregarded entities:  The four types of disregarded entities are: the Trustee of a Revocable Living Trusts; Illinois-type Land Trusts; Single Member Limited Liability Companies and Delaware Statutory Trusts.  We have discussed Trusts previously and will direct our attention in this article to Limited Liability Companies.

LIMITED LIABILITY COMPANIES (LLCs)

Use of disregarded entities provides flexibility in exchange planning.  For example, an individual who sells a Relinquished Property in his or her individual name may acquire the Replacement Property in a single member limited liability company.  This provides additional liability protection for the Taxpayer.  

Limited liability companies ("LLC") a creatures of state statutory law and may be considered as a disregarded entity in the following cases where the LLC has not made an election to be treated for tax purposes as a corporation. Where:

100% of the member interests are owned by a single legal entity or a natural person.

100% of the interests are owned by husband and wife as community property in a community property state.

The IRS has explicitly approved treating a single member LLC as indistinguishable from its only member. Pursuant to Revenue Procedure 2002-69 applicable in the community property states (Arizona, California, Idaho, Louisiana, Nevada, New Mexico, Texas, Washington and Wisconsin), an LLC owned solely by a husband and wife as community property can be considered a disregarded entity for federal tax purposes even though the LLC technically has two members, However, states such as North Carolina that are not community property jurisdictions do not fall under this Revenue ruling and the IRS has explicitly refrained from applying disregarded treatment to a married couple holding as tenancy by the entirety to their jointly owning a two member LLC for the purpose of utilizing Internal Revenue Code Section 1031 treatment. The LLC's in question are treated as what they are...two member entities.

DELAWARE LLC EXCEPTION

As an exception of limited application, it should be noted that the IRS has ruled that a two-member LLC formed under Delaware law was disregarded for Internal Revenue Code Section 1031 exchange purposes where all economic interests were held by one member and the function of the second member was solely to prevent a bankruptcy filing or other violation of the LLC's covenants with lenders.  The IRS has also ruled that the acquisition of all the ownership interests held by 2 different owners by a single buyer in a single transaction constituted an acquisition of the underlying assets owned by the LLC.

If you have any questions concerning the use of disregarded entities for Internal Revenue Code Section 1031 Exchange planning, please be sure to contact our helpful and experienced staff at STEC, The 1031 Professionals ™