How Revocable Living Trusts Impact a 1031 Exchange

A common question we get is how a client's Revocable Living Trust impacts their exchange. One of the major rules of a 1031 exchange is that you have to take title to your New Property in the same manner that you held title to your Old Property.

The question about Revocable Living Trusts generally arises where the client's Old Property was owned by their Living Trust, but the lender for their New Property will not make the loan to the trust. And occasionally we get a client who has sold their Old Property in their name, but for estate planning reasons would rather purchase their New Property in the name of a newly formed Living Trust.

The answer to their questions is that their Revocable Living Trust will have no impact on their exchange. To be clear, there are many different kinds of trusts, and each of them impacts a 1031 exchange differently, but a "Revocable Living Trust" will not affect what the client is trying to do.

The reason for this is that Revocable Living Trusts do not file income tax returns; any income or expenses, or gains or losses, are reported in the tax returns of the beneficiaries of the trust. Because the trusts don't file a return, the IRS calls them "disregarded entities". There are, currently, three types of disregarded entities: Revocable Living Trusts, Illinois Land Trusts and Single Member Limited Liability Companies. (We are hoping that Delaware Business Trusts will soon be added to the list, but that is a topic for a different article).

To understand why Living Trusts, or for that matter, the other two types of entities discussed above, do not violate the rule that title has to be the same for both the Old and New Properties, you have to look through to the actual tax return that owns each property.

Let's say, for example, that Fred and Sue Jones own the Old Property. This means that as husband and wife their joint tax return owns the property. If Fred and Sue acquire the New Property as the "Jones Revocable Living Trust" their same tax return will be acquiring the New Property since they own the trust and the trust does not file a tax return. In other words, although actually the title reads differently between the Old and New Properties, the same tax return was in title to both.

On final word of caution: the names of many trusts are different ¬ and they all have different handling in 1031 exchanges. For this reason, make sure that you are using a highly experienced and professional Intermediary and that you are discussing these issues with them as you proceed through your exchange.