Let’s say that you have a husband and wife (Mark and Sandra) doing a 1031 exchange.
Mark and Sandra own the old relinquished property. When they go to acquire the replacement property the same taxpayers that owned the old property should acquire the new replacement property. So in our example Mark and Sandra should purchase the replacement property so that when they report their taxes on IRS form 8824 they can show that they disposed of a relinquished property and acquired a new replacement property.
But what if Mark wants to set up an LLC to buy the replacement property? Will that LLC be deemed to be the same taxpayer as Mark and Sandra individually?
The answer to that question can depend on what state Mark and Sandra live in. If Mark and Sandra are in a community property state such as Wisconsin or California the common ownership of that LLC by Mark and Sandra will still be viewed as a disregarded entity – a pass-through – where the IRS sees Mark and Sandra as the taxpayers behind the LLC according to Rev. Proc. 2002-69. In this situation, both spouses also have to file a joint tax return.
Community Property States Include:
- New Mexico
In that case Mark and Sandra could buy the replacement property by and through that disregarded LLC. The problem is that most states are not community property states – they’re common law states. In those states a husband and wife are not considered to be a single member or owners of a disregarded entity. A husband and wife in an LLC could create and would create a separate and distinct taxpayer.
So in non-community property States the options for the taxpayers are either to:
- Acquire the replacement property in their own individual names – Mark and Sandra
- Create two new single member LLCs – one owned by Mark, one owned by Sandra – and have those two LLCs acquire the replacement property as tenants-in-common.
There’s still a continuation of investment by the same taxpayers, they’re simply bifurcating their ownership into two separate and distinct single member disregarded LLCs.