Can I 1031 property held in an Illinois-style land trust?

The IRS looks through a typical land trust to the beneficiary

In an Illinois-style land trust a corporate trustee holds legal and equitable title under a deed in trust, and a separate land trust agreement gives the beneficiary every practical right in the property. The IRS summarized its ruling on that arrangement in Rev. Rul. 2004-86: the taxpayer 'retained exclusive control of the management, operation, renting, and selling of the real property, together with an exclusive right to the earnings and proceeds,' and had to file the returns and pay the taxes.

On those facts, Rev. Rul. 92-105 concluded that 'a trust, as defined in Section 301.7701-4(a), was not established' and that the trustee 'was a mere agent for the holding and transfer of title to real property.' The taxpayer 'retained direct ownership of the real property for federal income tax purposes.'

That is why the beneficiary, not the trustee, is the exchanger, and why an exchange of the beneficial interest qualifies as an exchange of real estate. It also means the beneficiary reports the rent and depreciation directly, as most land trust owners already do.

The trustee signs, but the exchange documents should name you

On the sale, the trustee executes the deed and closing documents on your written direction. The exchange agreement with the intermediary, the assignment of the sale contract and the identification notice should identify you as the taxpayer, with the trust described as the record titleholder.

The identification notice under Reg. Section 1.1031(k)-1(c)(2) must be a written document 'signed by the taxpayer', so sign it yourself as beneficiary rather than asking the trustee to send it. The trustee has no authority beyond holding title and is not part of your exchange.

At closing, the buyer's money must go to the qualified intermediary, not to the trustee. Land trust trustees commonly disburse proceeds to the beneficiary as a matter of course, so give written instructions in advance.

The replacement can go into the same trust, a new trust or your own name

Because the land trust is ignored, a replacement deeded to the same trustee under the same trust number, to a new land trust with you as sole beneficiary, or directly to you is acquired by the same taxpayer. Pick the vesting for privacy, financing and estate planning reasons rather than tax ones.

Lenders financing the replacement may want the beneficial interest collaterally assigned and the trustee to sign the mortgage. That is ordinary land trust practice and does not change who the taxpayer is.

If you sell in your own name and want the replacement in a land trust, the same logic applies in reverse. For a revocable living trust, which is a different structure, see selling in your own name and buying in a revocable trust.

Worked example: a two-flat held in a land trust

Hypothetical, round numbers; run your own numbers with your CPA. You are sole beneficiary of a land trust holding a Chicago two-flat worth $700,000 with an adjusted basis of $250,000. You direct the trustee to sign the sale contract and deed, and you sign the exchange agreement and assignment as taxpayer.

The $700,000 goes to the intermediary. Within 45 days you identify a $750,000 small retail building, and you direct the same trustee to take title under a new trust number with you as sole beneficiary. Nothing is recognized, and your basis in the replacement starts from the old $250,000 plus the extra cash.

Had two siblings been co-beneficiaries operating the building together, the land trust might be classified as a partnership instead. Then the partnership would be the exchanger and the siblings could not each go their own way without the planning in multi-owner 1031 options.

Check the land trust agreement before you sell

Rev. Rul. 92-105 turns on the trustee having no duties beyond holding and transferring title. Read the land trust agreement for trustee powers to manage, lease or borrow on its own initiative, and for arrangements among several beneficiaries, because either can move the classification.

A land trust is also different from a Delaware Statutory Trust. A DST is classified as a grantor trust in which investors hold fractional beneficial interests treated as interests in real property, as Rev. Rul. 2004-86 explains, but it has a sponsor and a trustee with limited, defined powers. Owners who want to stop managing property often use the land trust sale to move into DST interests; DST property held in an LLC or trust covers how the subscription is titled.