Using ‘Disregarded Entities’ in a 1031 Exchange

One of the basic rules for holding title to property in a 1031 exchange is: “how you hold title to your old property is how you have to take title to your new property.”

This means that the title to the new property has to be taken by the same tax return that held title to the old property. For example, if Sue owns her old property in her personal name, she cannot have her corporation take title to her new property: the tax return that owns the old property (Sue’s) is a different entity from the tax return that will take title to her new property (her corporation’s). This exchange will fail.

There are four “exceptions” to the title holding rule (actually, as you will see, they are not really exceptions per se, but simply variations). These involve the use of what the IRS calls “disregarded entities.” A disregarded entity is an entity that holds legal title to property but is not required to file an income tax return. The four types of disregarded entities are: Revocable Living Trusts; Illinois-type Land Trusts; Single Member Limited Liability Companies and Delaware Statutory Trusts.

A Revocable Living Trust is an estate planning device designed to avoid probate. This type of trust holds title to property, but doesn’t file a tax return. This means that if Sue owns her old property in the ‘Sue Jones Revocable Living Trust,’ her individual income tax return (IRS Form 1040) actually owns it, even though the Trust holds title to the old property. Therefore, Sue can take title to the new property in her own name rather than having to take title in the name of the Revocable Living Trust, because her personal tax return owned both the old and new properties.

To read more about disregarded entities, check out the article by Gary Gorman in the Colorado Real Estate Journal.

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