Did You Buy Substantially The Same Property That You Identified In Your 1031 Exchange?

I know, I know.  You are wondering what I've been drinking.  But, this is a real issue.  In fact, It is a really critical issue when you are being audited.

It does in fact come up during income tax return audits, especially when the California Franchise Tax Board is the audit agency.  The California Franchise Tax Board has been taking very hard look at just this issue.  We've been brought in as 1031 Exchange experts on audit cases for this very issue. 

Actual Case Study
Let's look at an audit case that we recently consulted on.  The investor/taxpayer sold a property ("relinquished property") and structured a 1031 Tax Deferred Exchange transaction.  The investor/taxpayer identified his intended purchase ("replacement property") within the required 45 calendar day identification period.

His identification read like this: 12345 Main Street, Anytown, CA 92345

He made an offer, which was accepted, to buy an undivided ten percent (10%) interest in his identified property, and he actually closed on the purchase of the fractional interest well within his 180 calendar day exchange period.

Acquiring Substantially The Same Property
The issue is this, by identifying the property as 12345 Main Street, he has effectively identified 100% of the property as his intended replacement property.  However, he only acquired a ten percent (10%) interest in the property. 

The question then becomes, did he actually acquire substantially the same property as the property that he identified if he only acquired ten percent (10%) of what he actually identified. 

I know, I know, this is like splitting hairs.  But, the California Franchise Tax Board is taking this very position right now.  They have disqualified the 1031 Exchange under audit because he did not acquire substantially the same property that he identified. 

Investors/taxpayers structuring 1031 Exchanges must be very, very careful when identifying their intended like-kind replacement properties so that they do not run afoul of the hyper-critical taxing authorities today. 

What Exactly Is A Self-Directed IRA?

I just spoke with a taxpayer that asked, "Well, what exactly is a self-directed IRA.  This is actually a very good question; one that is often very misunderstood, because all individual retirement accounts or IRAs are self-directed! 

Self-Directed IRAs Allow Alternative Investments
The retirement services industry has loosely used the term self-directed IRA to describe IRAs that allow the taxpayer/investor to buy "alternative investment" such as real estate, Deeds of Trust, Mortgages, Tax Lien Certificates, and more, inside of their IRA. 

All IRAs Are Self-Directed IRAs
However, the taxpayer/investor always chooses what financial institution to place their individual retirement account with, so they are ALL self-directed IRAs.  The taxpayer/investor can choose to open, transfer, withdraw and close their IRA at, to or from any institution they wish to work with.  So, you can see that all IRAs are self-directed IRAs. 

IRA Custodians or Trustees Are The Key
The real difference is the investments that an IRA Custodian or Trustee will allow the taxpayer/investor acquire inside of their IRA.  The majority of financial institutions do not permit "alternative investments," but there are about ten or so nationwide that do so.  So, the key is to identify the right IRA Custodian to suit you. 

1031 Exchange Basic Webinar by Bill Exeter (On Demand)

William L. Exeter, President and Chief Executive Officer of Exeter 1031 Exchange Services, LLC has over 30 years of experience in the fiduciary services industry and is a renowned real estate tax strategist.

Mr. Exeter joins Silver Stream Advisors’ President Gregg Wood and his team of real estate experts to bring you a brief education on buying real estate using 1031 Exchange strategies Mr. Exeter will provide you a greater understanding of what 1031 Exchanges are all about and how to invest using 1031 Exchanges, while Mr. Wood will discuss how Silver Stream Advisors’ trademarked Real Estate Money Machine™ investment model will grow your retirement and take advantage of the incredible investment opportunity in real estate.

Both Mr. Exeter and Mr. Wood are committed to providing investors the highest levels of experience, expertise and security of funds in the industry.

Join us for this on demand webinar.

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This webinar will teach you:

• What a 1031 exchange is
• How to sell & reinvest using a 1031 exchange
• 1031 exchange strategies and requirements
• How to regain control of your retirement using Silver
  Stream Advisors investment opportunities
• Tax strategies of the wealthy

For those prepared with the right tools, there has never been a better time to invest in real estate. Learn the secrets of the rich to control their financial future. We look forward to seeing you there.

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Is Your LLC Really a Single Member LLC?

Limited Liability Companies or LLCs are all the rave today for acquiring, holding, managing and disposing of real estate.  They are easy to form, easy to administer, and easy to deal with for income tax purposes, especially if the LLC is a single member LLC ("SMLLC").

Single Member LLCs Have One Member
Single member LLCs are Limited Liability Companies that have one and only one member (owner) for tax purposes. LLCs that have a husband and wife as the sole members may still be treated as a single member LLC if they live in a community property state and file a joint income tax return. 

The single member LLC generally uses the Taxpayer Identification Number ("TIN") or Social Security Number ("SSN") of the sole member, but can apply for its own separate TIN if it so chooses.  

Single Member LLCs Are Pass-Thru and Disregarded Entities
Single member LLCs are not only treated as pass-thru entities (income tax consequences inside of the LLC pass-thru to the sole member's income tax return) but are also treated as disregarded entities (SMLLC is ignored as if it does not exist for income tax purposes). The assets held (owned) inside the single member LLC are treated as if they are owned directly by the sole member for income tax purposes.

However, since they are generally so easy to administer it also means they are easy to screw up, especially because most taxpayers do not fully understand how the single member LLC should be treated and/or reported. 

I think the vast majority of those taxpayers who set-up limited liability companies intend to use, treat and report the LLCs as single member LLCs, but it is truly amazing how many accidentally end up as something other than single member LLCs.

Most Common Mistake Made
The most common mistake made with single member LLCs is when tax return preparation time comes around.  Generally, tax consequences from a single member LLC should be reported on the sole member's income tax return since the single member LLC is a pass-thru entity and a disregarded entity. 

Partnership Treatment; No Longer Single Member LLC
However, the taxpayer and/or his or her tax advisor all too often incorrectly file IRS Form 1065, which is a partnership income tax return.  There are many reasons used to "rationalize" why this was done, often for administrative convenience, but in the end Filing IRS Form 1065 effectively serves as an election by the taxpayer to treat the LLC as a partnership rather than a single member LLC. 

The LLC is still a pass-thru entity, but it is no longer a disregarded entity.  The LLC is now treated as a partnership and is now considered a completely separate and distinct legal entity from the taxpayer.  The taxpayer will receive a K-1 from the partnership. 

Complications For 1031 Exchanges
Why am I discussing this issue on my blog where I usually talk about 1031 Exchanges?  It absolutely affects the successful outcomes of 1031 Exchanges when there is a single member LLC involved in the sale or purchase of properties inside a 1031 Exchange. 

1031 Exchange Case Study
Let's review an example of what can go wrong when what is thought to be a single member LLC actually turns out to be a LLC that has been treated and reported as a partnership. 

Taxpayer owns property in a LLC.  Taxpayer is the sole member of the LLC and therefore assumes that the LLC is a single member LLC.  Taxpayer tells the Qualified Intermediary that the LLC is a single member LLC and that Taxpayer will be buying his or her replacement property in the same single member LLC. 

The Qualified Intermediary drafts the 1031 Exchange documents listing the single member LLC as the Exchangor (taxpayer/seller) for the relinquished property and the sale closes. 

The Taxpayer discovers that his or her lender will not lend to the LLC, so the Taxpayer is forced to acquire the replacement property in his or her individual name.  The replacement property closes and the legal title is in fact deeded (conveyed) into the Taxpayer's individual name and not the LLC. 

Generally, this would still qualify for tax-deferred treatment in a 1031 Exchange if the LLC is considered a single member LLC because it is a disregarded entity and the property owned by the LLC is treated as if it is owned by the underlying Taxpayer who is the sole member of the LLC.

However, if the Taxpayer had actually been filing IRS Form 1065 for the LLC, then the transaction may not qualify for tax-deferred exchange treatment because there would be two different entities involved in the transaction.  The sale would have been closed in a partnership's name and the subsequent purchase of the replacement property would have been closed in the individual's name.  The partnership and the individual are completely different taxpaying entities.  


Remember, properties must be sold and acquired by and in the name of the same taxpaying entity in order to properly structure a Tax-Deferred Exchange pursuant to Section 1031 of the Internal Revenue Code and the California Franchise Tax Board. 

California Franchise Tax Board Audit
I have been involved as an expert witness in two (2) transactions that were audited by the California Franchise Tax Board and in one (1) that was audited by the Internal Revenue Service.  


The issues and outcomes described above are the exact positions taken by the California Franchise Tax Board and the Internal Revenue Service.  Owners intending to use single member LLCs need to consult with their legal and tax advisors to ensure they are in fact treating, reporting, administering and documenting their LLCs as single member LLCs. 

Amy Sotereanos Joins Exeter 1031 Exchange as Affiliate

Exeter 1031 Exchange Services, LLC issued a press release regarding Amy Sotereanos joinning its national 1031 Exchange Services Group as a 1031 Exchange Consultant.  She is based out of the Pittsburgh, Pennsylvania Affiliate Office.

Amy Sotereanos has over ten (10) years of professional real estate experience in the areas of 1031 Exchanges and commercial real estate escrow services.  Mrs. Sotereanos was formerly the National Operations Manager for U.S. National 1031 Exchange, Inc. (formerly Mid-Exchange, Inc.).