BC-glink 12/29 TMS Original

Staff Writer
Columbus CEO

REAL ESTATE MATTERS For release 12/29/13

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1031 exchange made more difficult by LLC

Tribune Content Agency

By Ilyce Glink and Samuel J. Tamkin

Q: I am a member of a multi-member limited liability corporation (LLC) that owns a medical building in which my husband's company occupied an office and paid rent to the LLC. The building is about to be sold. I will receive a large profit in the sale.

I would like to take my share of the proceeds and reinvest the proceeds in a residential rental property (occupied and rented by my son). Will this exchange qualify under the rules of Section 1031? The LLC is an S-corporation for tax purposes. I assume after the sale of the medical building, the LLC will then liquidate. I do not want to be hit with a huge tax burden.

A: Let's try to deconstruct your story so we can address each piece. First, you are a member of a LLC that is a "multi-member" company. This statement is important, as the LLC is its own tax entity and it owns the medical office building. The LLC is selling the building and you, one of the members of the LLC, want to defer the payment of tax on that sale by exchanging the property the LLC is selling for a property you would own.

The bad news is that you can't get the benefit of a like-kind exchange, also known as a 1031 exchange. One of the basic rules of a 1031 exchange is that the seller of the prior property must be the buyer purchasing the new property. You fail this test. Some partnerships and LLCs will distribute the property to its members well in advance of the sale of the property. Each member of the LLC would get their share of the real estate and each member could then sell their share of the property to a buyer and set up a 1031 exchange to then buy a replacement property.

We don't know the details of your transaction or the way the LLC was created, but we'd suggest you talk to a 1031 company with extensive knowledge in this area, along with your accountant, to determine whether you can even distribute the property to the LLC members.

In some states, the distribution of the property could cause other tax problems for the members, and you'd have to distribute the real estate to the members in such a way as to avoid that transfer creating a taxable situation to the members.

If, after you talk to your accountant and the accountant for the LLC, you determine that all of the members are in agreement to distribute the real estate to the members, that it can be done for a very low cost, and that the transfer won't trigger state or federal income taxes, then you could move forward and sell the building.

You'd have to make sure to work with a reputable 1031 exchange company in that sale. The proceeds from the sale would be kept by the 1031 exchange company. That way, you never touch the funds. You'd have 45 days to designate the replacement property -- the property occupied and rented by your son. And, you'd have to close on the purchase of that property no later than the earlier of 180 days of the closing of the sale or your federal income tax return filing date.

Unfortunately, the requirements of Section 1031 of the Internal Revenue Code are quite strict. If you fail to follow any one of the requirements, your exchange will fail and you'll have to pay tax on the money for the year in which the sale occurred. One additional piece of information you and your other co-owners might consider is that starting this year, the IRS has an additional 3.8 percent tax on the sale of investment property.

So if you fall into the income thresholds and make over $200,000, if you are single, or $250,000, if you are married, you will be subject to this tax.

Here's one last issue you need to consider: If the seller of the property you intend to buy is related to you, you may have other IRS rules to satisfy. The IRS seems to believe that when family members sell each other property, there may be funny business involved, and they have other rules relating to those type of exchanges.

Consult with your tax advisor and/or a real estate attorney for more details.

(Ilyce Glink is the creator of an 18-part webinar and ebook series called "The Intentional Investor: How to be wildly successful in real estate," as well as the author of many books on real estate. She also hosts the "Real Estate Minute," on her channel. If you have questions, you can call her radio show toll-free (800-972-8255) any Sunday, from 11a-1p EST. Contact Ilyce and Sam through her website,