What is the “Same Taxpayer” Rule for a Like-Kind Exchange?

Like-kind exchanges under Section 1031 of the Internal Revenue Code are subject to several strict rules. Taxpayers seeking to conduct like-kind exchanges must strictly comply with these rules, and they must be prepared to demonstrate compliance to the Internal Revenue Service (IRS) when necessary. One of the least well-understood rules for like-kind exchanges is the “same taxpayer” rule. Find out what you need to know from a 1031 exchange expert:

Understanding the “Same Taxpayer” Rule for Like-Kind Exchanges

Fundamentally, the same taxpayer rule is straightforward: It requires that the same taxpayer be involved in both sides of a like-kind exchange. In order to qualify for indefinite tax deferral under Section 1031, the taxpayer that acquires a replacement property must be the same taxpayer that sells the relinquished property involved in the exchange.

In practice, applying the same taxpayer rule can be significantly more complex. Ultimately, however, this is a good thing for taxpayers, as it provides greater flexibility when conducting like-kind exchanges. For example, under the same taxpayer rule:

• A taxpayer who owns a relinquished property through a single-member LLC can establish a different single-member LLC to own the replacement property;
• Spouses can be added as owners of replacement properties (either directly or through an LLC), provided that the owner of the relinquished property owns a sufficient percentage of the replacement property;
• Business partners can be added as owners of replacement properties (either directly or through an LLC), provided that the owner of the relinquished property owns a sufficient percentage of the replacement property;
• Owners of relinquished properties can be excluded as owners of replacement properties; and,
• Taxpayers can use trusts (i.e., Delaware statutory trusts) and other investment vehicles to acquire, own, and transfer interests in relinquished and replacement properties.

The steps involved in pursuing each of these options (and others) vary, and it is important to ensure that taxpayers meet all relevant requirements to satisfy Section 1031’s same taxpayer requirement. Similar to other forms of noncompliance, if a purported like-kind exchange does not comply with the same taxpayer rule, this can prevent taxpayers from securing indefinite tax deferral. In this scenario, the full gain realized from the sale of the relinquished property becomes subject to immediate federal taxation.

A Closer Look At Three Common Examples

While there are several options for conducting a like-kind exchange in compliance with Section 1031’s same taxpayer rule, certain options are particularly common. Here is a closer look at three common scenarios:

1. Using Single-Member LLCs to Own Real Estate

Under the same taxpayer rule, the owner of a single-member LLC can form a new single-member LLC to hold the replacement property acquired in a like-kind transaction. This is because single-member LLCs are “disregarded entities” for federal tax purposes (unless a taxpayer elects otherwise). In this scenario, the individual owner of the LLCs is considered the “taxpayer” even though he or she is not named on the deed for either property.

2. Spouses Forming an LLC to Own a Replacement Property

If spouses own a piece of property in their individual names and want to conduct a like-kind exchange that involves placing their replacement property into an LLC for liability mitigation purposes, the steps they need to take depend on where they live. In some states, an LLC owned exclusively by two married spouses is classified as a disregarded entity. In other states, however, the spouses may need to form two separate single-member LLCs in order to comply with the same taxpayer rule in this scenario.

3. Conducting a Like-Kind Exchange with Multiple Owners

In other scenarios involving multiple owners, each individual owner must generally conduct a like-kind exchange in order to avoid immediate tax liability. However, there are additional mechanisms for conducting like-kind exchanges involving syndications and other large-scale investment ventures, and with these kinds of ventures, it is critical to ensure that the legal entities involved are properly structured to allow all owners participating in the exchange to claim indefinite tax deferral.

Again, these are just a few of the most common scenarios. If you have questions (or concerns) about the same taxpayer rule for conducting a like-kind exchange, a 1031 exchange expert at our offices can walk you through all of the options that are available based on the specific circumstances of your exchange.

Schedule a Free Consultation with a 1031 Exchange Expert

At 1031 National Services, we have experience helping our clients satisfy Section 1031’s same taxpayer requirement under a wide range of circumstances. If you would like to discuss your options with a 1031 exchange expert in confidence, please call 888-872-1031 or request a free consultation online today.