We own the property jointly as spouses. Can we sell and buy the replacement in an LLC we both own?

A two-member LLC is a separate taxpayer unless something makes it disregarded

Reg. section 301.7701-3(b)(1) sets the default: a domestic eligible entity is a partnership if it has two or more members and is disregarded if it has a single owner. Spouses are two members. Filing a joint return does not change that count.

A partnership files its own return and owns its own property. If you and your spouse sell as individuals and a partnership buys, the taxpayer who sold is not the taxpayer who bought. Contributing exchange proceeds to a new partnership is not saved by the fact that you own it, because an interest in a partnership is listed as not real property in Reg. section 1.1031(a)-3(a)(5).

A single-member LLC is different. Reg. section 301.7701-2(a) treats a disregarded entity's activities in the same manner as a sole proprietorship, branch or division of its owner, so the owner is still the taxpayer. Can an LLC do a 1031 exchange covers the general rule.

Community property states have a specific safe position

Rev. Proc. 2002-69 covers an entity wholly owned by a husband and wife as community property under the laws of a state, a foreign country or a possession, where no one else would be treated as an owner and the entity is not a corporation. If the spouses treat it as disregarded, the IRS will accept that; if they file partnership returns, the IRS will accept that instead. Switching reporting positions is treated as a conversion of the entity.

So in a community property state, a couple selling community property can buy through an LLC they own as community property and report it as disregarded. The exchange stays with the two of you, as it would have if you had bought in your own names.

Check that the property and the LLC interests really are community property under your state's law, and that no prior partnership return was filed for the entity.

Joint tenancy and tenancy by the entirety do not qualify for that relief

The revenue procedure is limited to community property. Joint tenancy and tenancy by the entirety are not community property, so an LLC owned by spouses in those states is a two-member partnership by default.

The married-couple qualified joint venture election does not help either. The IRS explains that the election covers only businesses owned and operated by spouses as co-owners, not in the name of a state law entity such as an LLC, and that mere joint ownership of property that is not a trade or business does not qualify.

Two single-member LLCs keep each spouse as their own taxpayer

The usual answer outside community property states is to mirror the old ownership. Each spouse forms an LLC with themselves as the only member, and the two LLCs take title as tenants in common, each to the share that spouse held in the relinquished property.

Hypothetical: you and your spouse each own half of a rental sold for $1,200,000. Spouse A's LLC and Spouse B's LLC each take a 50 percent tenancy-in-common interest in a $1,400,000 replacement. Each LLC is disregarded, so each spouse has sold half and bought half. Run your own numbers with your CPA.

• Set up the LLCs before the replacement closes and give the intermediary the operating agreements.
• Match each spouse's share of the replacement to that spouse's share of the relinquished property and of the exchange funds.
• Confirm with the lender that it will lend to two LLCs as tenants in common; some lenders prefer a single borrower.
• Do not make a classification election on Form 8832 for either LLC unless your CPA wants it.

Merging into one LLC later is a separate decision

Some couples close in their own names or in two single-member LLCs and later move the property into one jointly owned LLC. That later step creates a partnership, and contributing exchange property to one soon after the exchange can raise the question whether you held it for investment as section 1031(a)(1) requires.

Treat that as its own planning step with your CPA and attorney. Moving from your personal name into an LLC and adding or removing a spouse on title cover the neighbouring questions.