Same Taxpayer Requirement

For a successful §1031 exchange, the taxpayer that will hold title to the Replacement Property must be the same taxpayer (or “tax owner”) that held title to the Relinquished Property.  Exchangers must be aware of this same taxpayer requirement when planning an exchange.  General examples of this include:

• Husband relinquishes; husband must acquire
• XYZ LLC (an LLC with 3 members) relinquishes; XYZ, LLC must acquire
• Dollar Corp. relinquishes; Dollar Corp. must typically acquire
• Payne Family Partnership relinquishes, Payne Family Partnership must acquire

Some Exceptions

Exceptions to this rule apply when dealing with entities that are disregarded for federal income tax purposes.  Some examples are:

• An exchanger may sell a Relinquished Property held individually and acquire Replacement Property titled in the name of a single-member LLC as long as the Exchanger is the sole member of the LLC and the single member LLC is treated as a disregarded entity.  
• An exchanger’s revocable living trust or other grantor trust may acquire Replacement Property in the name of the Exchanger as an individual so long as the relinquishing trust is disregarded for Federal Tax purposes.
• The exchanger’s estate may complete an in-process exchange after the exchanger dies following the sale of the Relinquished Property.

Ramifications

Selling Relinquished Property held in one entity such as a partnership or multi-member LLC and acquiring Replacement Property in the name of a different partnership or LLC or in the name of individual partners or in the name of individual LLC members will disqualify an exchange from non-recognition of gain because the exchange is being completed by a different taxpayer than the one starting the exchange.  Similarly adding a party to vesting can be problematic.  For example, a husband selling Relinquished Property and acquiring Replacement Property as husband and wife can result in partial recognition of gain by the exchanging husband.

To avoid a failed exchange, the exchanger generally should not make changes to the vesting of the Relinquished or Replacement Properties in the year prior to or during an exchange.  It is important that an exchanger consult with their tax or legal advisor(s) regarding how vesting could impact the structure of their specific exchange before they transfer the Relinquished Property.  Proper planning is important to conducting a successful exchange.