To properly exchange investment property under IRC §1031, the taxpayer must hold title to the replacement property exactly as they held title to the relinquished property, with very few exceptions. In other words, the person or entity beginning the exchange must be the same person or entity completing the exchange. For example, if one spouse owns the relinquished property, then only that spouse may acquire the replacement property*.
M ost often, problems will arise in situations where a husband or wife owns property separately and the lender requires that both the husband and wife take title to the replacement property in order to qualify for a loan. Adding the spouse on the title to the replacement property may cause the 1031 exchange to fail. It is important for the taxpayer to anticipate any vesting issues that may arise prior to the exchange because these issues are much easier to resolve before going to closing.
The Internal Revenue Service has permitted one major change to the general rule. An individual taxpayer may purchase the replacement property in an entity, in which the taxpayer is the sole shareholder or member. This issue has allowed individual taxpayers to convert their properties to LLC’s or Corporations and achieve liability protection.
*Certain exceptions apply in Community Property states.
The following are some examples of exceptions that would be prohibited.
1. Husband or wife relinquishes and husband and wife acquire*;
2. ABC Corporation relinquishes and XYZ Corporation acquires;
3. ABC Partnership relinquishes and XYZ Partnership acquires;
4. ABC Partnership relinquishes and partners acquire property as individuals;
5. Multi-member LLC relinquishes and members acquire property as individuals; and
6. ABC multi-member LLC relinquishes and XYZ multi-member LLC acquires.
Vesting Issues – Capital 1031 Exchange Company