Six things you need to know about §1031 - Part 5 The Proper Title-Holding Rule

Section 1031 allows you to roll the gain from the sale of your Old Property to the purchase of your New Property. To do this, you have to jump through certain hoops. We've talked in previous articles about how your property has to be held for investment and that it can not be held for resale.

We've also talked about the requirement to identify potential replacement properties for your exchange and how you have to complete a list of these potential properties within 45 days. We talked about the requirement that whatever you purchase must be on your 45 day list. And then last month we talked about how your money must be held by an independent third party called a Qualified Intermediary (QI) and how you must make sure that the intermediary holds your money in an account separate from other exchanges.

This month let's talk about the fifth rule which requires that you take title to the new property in the same name or entity that held title to your Old Property. Essentially, you have to make sure that it is the same tax return: individuals, corporations, partnerships, limited liability companies (LLCs), trusts, estates, etc. can all do 1031 exchanges - it just has to be the same tax return.

For example, if Microsoft Corporation owns the building you are in (as you read this), Microsoft has to buy the replacement property. It can't be one of Microsoft's subsidiaries, or even Bill Gates himself, because they are not the same tax return that sold the Old Property.

Likewise, if your building is owned by the FGH Partnership, which is owned equally by Fred, George, and Howard and you sell the building for $300,000, the FGH Partnership has to do the exchange and buy the New Property because the FGH Partnership is the tax return that owns the Old Property. Fred could NOT do a 1031 exchange and buy the New Property in his name because he is not the tax return in title on the Old Property.

Where things get confusing is when Fred, George and Howard have bought the Old Property as tenants-in-common, meaning that their three separate tax returns own the property. Then at the end of the year their accountant files a partnership return for the property. Now the IRS sees the partnership tax return as the owner of the property, even though the title is held by the same three guys.

Make sure your QI has both accounting and legal skill sets, as this fifth rule of proper title holding is extremely important in a successful 1031 exchange! In summary, follow the tax return when you do a 1031 exchange.