Can I buy the replacement from an LLC I partly own?

Above 50 percent, counting your family's stakes, the LLC is a related seller

Section 1031(f)(3) defines a related person by pointing to section 267(b) and section 707(b)(1). An LLC taxed as a partnership is related to you if you own, directly or indirectly, more than 50 percent of its capital interest or its profits interest. If the LLC elected to be taxed as a corporation, section 267(b)(2) applies the same more-than-50 percent test to the value of its stock.

Indirect ownership is where people get caught. Section 707(b)(3) measures your stake using the constructive ownership rules of section 267(c), so interests held by your spouse, brothers and sisters, parents, grandparents, children and grandchildren are counted as yours, as are interests held through other entities you own.

So an LLC where you own 30 percent and your daughter owns 25 percent is a related seller, even though you are a minority member on paper.

A related LLC that walks away with cash sinks the exchange

In Rev. Rul. 2002-83, a taxpayer sold low-basis property through a qualified intermediary, and the intermediary used the proceeds to buy high-basis replacement property from a related party, who kept the cash. The IRS treated the exchange as part of a transaction structured to avoid the related-party rule under section 1031(f)(4), and the full gain was taxed.

Teruya Brothers is the litigated version. The taxpayer owned 62.5 percent of the company that sold it the replacement properties through an intermediary. The Tax Court denied deferral in 2005 and the Ninth Circuit affirmed in 2009, noting the related parties had used the exchanges to cash out of low-basis real estate.

The Form 8824 instructions now tell you what to do in that situation: if a related party sold the replacement into the exchange for cash or other non-like-kind property, do not report the transaction on Form 8824 unless a line 11 exception applies, and report the sale of your relinquished property as if it were a sale.

At 50 percent or less, the questions become price, form and what you already own

Below the line, no related-party rule applies and the LLC is just another seller. Three practical points remain. Pay fair market value, because the LLC's other members are entitled to it and an off-market price invites the question of what else was exchanged.

Buy the property, not your partners' membership interests. Reg. section 1.1031(a)-3(a)(5) lists interests in a partnership among the intangibles that are not real property for section 1031, whatever state law says.

Remember that your share of the LLC's gain on the sale still reaches you. Section 702 passes each partner's distributive share of partnership gains through to the partner, so buying from an LLC you partly own does not erase your slice of its gain. If the LLC is a single-member LLC you own alone, it is disregarded and you would be buying property you already own, which is the problem in a 1031 on property you already bought.

Worked example: the same building, two ownership charts

Hypothetical, round numbers; run your own numbers with your CPA. You sell a rental for $1,500,000 with $900,000 of realized gain and want to buy a $1,500,000 warehouse owned by an LLC that bought it years ago.

Chart one: you own 40 percent and two unrelated investors own 60 percent. The LLC is not related to you. Your intermediary buys the warehouse for cash, your $900,000 gain is deferred, and the LLC reports its own gain, 40 percent of which shows up on your Schedule K-1 from the LLC.

Chart two: you own 40 percent and your brother owns 20 percent. Attribution gives you 60 percent, the LLC is related, and it is taking cash. Absent a line 11 exception, the $900,000 gain is taxed in the year of your sale, as if no exchange had happened.

What to do before you identify the property

Draw the ownership chart before day 45, with every member's family relationship to you and every entity layer. If you land above 50 percent, there are only narrow versions that work, set out in buying replacement property from a relative: broadly, the related seller does its own exchange and receives like-kind property rather than cash, and both sides hold for two years under the two-year rule.

If the LLC cannot do that, identify replacement property from unrelated sellers instead. A beneficial interest in a Delaware Statutory Trust is bought from a sponsor with no ownership tie to you, so it can serve as a backup on the same identification list. For how ownership tiers are counted generally, see who counts as a related party.