My rental LLC elected S-corp status. Does that change my 1031 exchange?

The S election made your LLC a corporation, and the corporation owns the rental

An LLC is an eligible entity that can choose its classification. Reg. Section 301.7701-3(c)(1)(v)(C) says an eligible entity that timely elects S status 'is treated as having made an election under this section to be classified as an association', which means a corporation. The deemed election stays in place until the entity elects otherwise.

If the LLC was disregarded before the election, the regulation deems a specific transaction: 'The owner of the eligible entity contributes all of the assets and liabilities of the entity to the association in exchange for stock of the association.' From that day the building belongs to the corporation for every federal tax purpose, whatever the deed says.

So the exchanger is the company. It signs the exchange agreement with the intermediary, takes title to the replacement and reports the exchange on Form 8824 with its Form 1120-S. The gain it defers is the corporation's gain, and the replacement's basis is the corporation's basis.

The corporation can complete a normal exchange

Section 1031(a) applies to any taxpayer holding real property for productive use or investment, and a corporation qualifies like an individual does. The 45-day and 180-day periods, the identification rules and the qualified intermediary safe harbor all work the same way.

Items pass through to shareholders under section 1366, so any boot the corporation recognizes shows up on your Schedule K-1 rather than being taxed at the corporate level. The exception is a company that was a C corporation before it elected S status: section 1374 taxes net recognized built-in gain during the 5-year recognition period that begins on the first day of the first S year.

A corporation can also buy a Delaware Statutory Trust interest as replacement property, provided the offering accepts entity investors and the corporation meets the investor standards. The trust interest is then a corporate asset, with the same exit constraints described below.

Taking the property out of the company first is a taxable sale

Shareholders often ask whether they can distribute the building, exchange it in their own names and be rid of the corporation. Section 311(b) answers that: when a corporation distributes property worth more than its basis, 'gain shall be recognized to the distributing corporation as if such property were sold to the distributee at its fair market value.'

Section 1371(a) applies those subchapter C rules to S corporations, and the gain flows through to you on the K-1. A full liquidation has the same result under section 336(a). Revoking the S election does not help either; the entity simply becomes a C corporation that still owns the building.

Converting back to a disregarded entity by election is treated under Reg. Section 301.7701-3(g)(1)(iii) as the association distributing all of its assets to its owner in liquidation, so it triggers the same corporate-level gain. The structure you chose for payroll purposes is now a structure you exit only by paying tax.

Worked example: exchange inside the company versus pulling the property out

Hypothetical, round numbers; run your own numbers with your CPA. An S corporation that has never been a C corporation owns a rental worth $1,200,000 with an adjusted basis of $500,000, so the built-in gain is $700,000. You are the only shareholder.

If the corporation sells through an intermediary and buys a $1,300,000 replacement, it recognizes nothing, and its basis in the replacement starts from the old $500,000 plus the added cash. You receive no K-1 gain from the sale.

If the corporation instead deeds the rental to you so you can exchange personally, it recognizes $700,000 as if it had sold to you. That gain passes through to you in the year of the distribution, and your own exchange then begins with a $1,200,000 basis. The tax you were trying to defer has been paid in full.

• Exchange inside the S corporation: no gain recognized, deferral stays in the company.
• Distribute then exchange: $700,000 of gain recognized and passed through first.
• Liquidate the company later: the same corporate-level gain, measured on the replacement at that time.

What to do before you list the property

Confirm the entity's tax classification from its last return before anyone drafts the exchange agreement. Many owners believe they have a disregarded LLC when the company has been filing Form 1120-S for years.

Have the corporation, by its exact legal name and EIN, sign the listing agreement, the purchase contract and the exchange agreement, and plan for it to take title to the replacement. The broader trade-offs of holding real estate in a corporation are covered in 1031 exchanges for S and C corporations, and the rules for keeping the same taxpayer on both sides in the same-taxpayer rule.

If the shareholders disagree about what comes next, the exit questions are similar to those in when one partner wants cash, but stock and corporate distributions follow different rules from partnership interests, so have your CPA model each path before contracts are signed.