When trying to meet the criteria of I.R.C. 1031 exchange properties, the taxpayer and the owner of the relinquished property should be the same taxpayer who receives the replacement property. As in most real property deals, there are certain tricks. Let’s specifically look at the role of Revocable and Irrevocable Trusts, and Land Trusts in relation to a 1031 exchange.
What Are Disregarded Entities?
Any individual as the Exchanger can utilize a disregarded entity in a 1031 exchange like a single-member limited liability company (SMLLC). It can also have a revocable living trust as the entity that receives replacement property on their behalf. Revocable living trusts and SMLLC’s are generally considered disregarded entities. The Exchanger files a single return using their own TIN or tax identification number and not a different E.I.N. for the L.L.C. or Trust. The “Continuity of Investment” is upheld as the Exchanger is still regarded as the “same taxpayer” when utilizing a disregarded entity.
Basics Of A Trust
Let’s have a quick look at the principles of a Trust. There are various types of trusts with different strategic benefits. We will only focus on revocable and irrevocable living trusts and land trusts in this blog. The main function of a Trust in relation to real property is to safeguard the assets from probate upon the passing of the Grantor.
Moreover, certain kinds of Trusts can offer added privacy to the property of the taxpayer. Trusts can be utilized in many ways in 1031 exchanges, but based on their special characteristics, they must still meet all 1031 criteria. Typically in a trust, there are three parties: the Trustee, the Grantor or Settlor, and the Beneficiary. The Trustee is the individual who’s responsibility is to administer the trust. The Grantor or Settlor usually creates trust. The Beneficiary is one who would benefit from the trust by acquiring the real property assets after the passing of the Grantor.
What Are Revocable or Living Trusts?
Revocable (Living) Trusts include the most common type of trust. Revocable Living Trusts never file independent tax returns as all expenses, income, gains or losses are recorded on the tax return of the Grantor of the trust. As the name of the trust suggests, at any time in the lifetime of a Grantor, the trust can be revoked or amended. Typically, the Trustee and the Beneficiary (ies) are all the same individual. This enables the taxpayer to sell their relinquished property with the trust on the title and obtain their replacement property as a single member L.L.C. or an individual.
These Trusts fundamentally differ from Revocable Trusts as they cannot be changed or amended by the Grantor once they have created it. The Grantor effectively removes all ownership rights to the assets once the trust holds them. The basic difference for purposes of 1031 exchange treatment is that an Irrevocable Trust comes with its own separate tax identification number. That’s why the Irrevocable Trust is considered the taxpayer in a 1031 exchange.
Land trusts created in Indiana, Illinois, Hawaii, North Dakota, Virginia, and California are considered interests in real property and eligible for a 1031 tax deferral. There are certain rules that Land trusts with multiple beneficiaries must follow to not be considered a partnership; first, no agreement between the taxpayer and beneficiaries exists that establishes a partnership. Partnership interests are not 1031 eligible. Revenue Ruling 92-105, 1992-2 C.B. 204 states that real property held by a land trust is not a beneficial interest in the trust or an interest in personal property.
Individual tax situations can differ and can be quite complex. It is advisable to seek guidance from a tax professional in a specific situation. If you are searching for a 1031 exchange properties, call 1031 Xchange at 888-993-2835 or drop an email: info@1031Xchange.com