1031 Exchange Guide for Real Estate and Estate Attorneys

Contract language: assign to the intermediary with written notice, and make the replacement contract assignable

Reg. section 1.1031(k)-1(g)(4)(v) treats an intermediary as entering into a contract the client signed if the client's rights 'are assigned to the intermediary and all parties to that agreement are notified in writing of the assignment on or before the date of the relevant transfer.' The cooperation clause is not legally required, but it obtains the counterparty's consent to the assignment and to signing the notice, and it allocates any added cost to your client. The cooperation clause answer lists the usual terms.

Review the exchange agreement as closely as the purchase contract. Under paragraph (g)(6) the agreement must provide that the client has no rights 'to receive, pledge, borrow, or otherwise obtain the benefits of money' held by the intermediary before the end of the exchange period, with narrow exceptions after day 45 if nothing was identified or after all identified property is received. A side letter that gives the client earlier access can disqualify the whole arrangement.

For a reverse exchange the property is parked with an exchange accommodation titleholder under Rev. Proc. 2000-37: the qualified exchange accommodation agreement must be signed within five business days after title passes to the titleholder, and the combined parking period may not exceed 180 days. Name the titleholder as a permitted assignee in the purchase contract.

Entity and title: the taxpayer is determined by tax classification, not by the name on the deed

Under Reg. section 301.7701-3(b)(1), a domestic eligible entity with one owner is disregarded unless it elects otherwise, and one with two or more members is a partnership. A client can therefore sell in their own name and buy through a new single-member LLC; a two-member LLC that owns the property is the exchanger, and its members cannot each exchange separately without restructuring. The same-taxpayer rule covers spouses, trusts and entity changes.

Watch for related-party problems when the replacement comes from, or the relinquished property goes to, family or a controlled entity. Section 1031(f) undoes the deferral if either party disposes of the exchanged property within two years after the last transfer, subject to listed exceptions including death. Who is a related party for a 1031 has the list.

Trusts and estates: a revocable trust is the grantor, and the plan for the replacement must not undercut investment intent

Section 676 treats the grantor as owner of any portion of a trust the grantor can revoke, so a sale by the client and a purchase by the client's revocable trust is one taxpayer; see selling in your own name and buying in a revocable trust. Irrevocable non-grantor trusts are separate taxpayers and must be both seller and buyer.

Planned transfers after the exchange need care. In Magneson v. Commissioner, the Ninth Circuit noted that an intent at the time of the exchange to liquidate the replacement, including an intent to give it away as in Click v. Commissioner, 78 T.C. 225 (1982), disqualifies the exchange. Do not draft a gift of the replacement into the same plan that closes it.

At death, section 1014 resets the basis of property acquired from a decedent to fair market value, erasing the deferred gain from every earlier exchange. For an older client, that can make holding the current property, or one last exchange into passive property, the better plan; the executor's guide to a 1031 covers exchanges in progress at death.

Drop-and-swap timing: the case law supports a contribution after the exchange, and the risk sits in a distribution just before it

Magneson held that real estate acquired in an exchange and contributed the same day to a partnership for a general partnership interest was still held for investment, because the partnership held it for investment and its assets were predominantly like kind. The court affirmed nonrecognition on both the exchange and the contribution. That supports a swap-and-drop; it says nothing directly about distributing property out of a partnership immediately before a sale.

When partners want to go separate ways, the distribution to tenancy-in-common owners, the deed, the leases and the sale contract all show who the seller really is. Allowing time between the distribution and the sale, and having the co-owners sign the contract individually, are the usual protective steps. Drop-and-swap strategies covers the sequence and the reporting.

DST documents: the client signs a subscription and accepts a trust agreement it cannot negotiate

Under the Delaware Statutory Trust Act, a beneficial interest is 'personal property notwithstanding the nature of the property of the statutory trust' and is 'freely transferable except to the extent otherwise provided in the governing instrument.' Review the trust agreement's transfer, death and successor-trustee provisions against the client's estate plan, and confirm how the interest will be titled: individually, in a revocable trust or in a disregarded LLC.

The trust agreement will carry the restrictions from Rev. Rul. 2004-86: no new contributions, no renegotiation of the loan or the lease, no new property. It usually also provides for conversion to an LLC if the trust cannot operate within those limits; the DST springing LLC explains the consequence for a later exchange.