My Need for 1031 exchange,
- I have a rental property “relinquished” worth 140k would like to sell this and buy a rental property “replacement” worth 300k. The relinquished property is in a different state. The replacement property will be in my state and my town. It is very convenient and economical to manage it locally.
- All the relinquished rental property’s proceeds will be invested towards the 300k replacement rental property.
- They both are exactly the “like-kind” properties and will be continued to use as rentals.

Option A: Forward Exchange
- Since there is no buyer for the relinquished property yet, can I sell this to a related party? The related party in this case my wife. She owns an LLC company with 100% ownership. This is primarily a real estate company. They is one property in this LLC currently and it does all the property management tasks.
- She will keep and manage the relinquished property in the same manner (as a rental) for the next two years.
- The company (wife) will raise 140k to acquire the relinquished property.

Option B: Reverse Exchange
- I need to raise 140k to invest in the replacement property.
- What happens if the relinquished property sells for 160k? Do I pay the capital gain for remaining 20k and re-claimed depreciation for the last 10 years?
- What happens if the relinquished property sells for 120k?
- If I cannot find a buyer for the relinquished property in 180 days, can I sell it to my wife’s company?

Please let me know the best option for me.

Thanks!

Option A: Forward 1031 Exchange with Related Party

Your wife is not a related party, but would be considered the same party since you are married and file a joint income tax return.  However, using an related entity that she owns can work.  It will depend on the related entity that is used to acquire your relinquished property.  The LLC owned 100% by your wife (related entity) WILL work IF she has elected to treat the LLC as a corporation for tax purposes (i.e. it is treated as a regarded entity and not a disregarded entity).  It WILL NOT work if the LLC is being treated as a single member LLC (a disregarded entity). 

Option B:

The Internal Revenue Service issued a Private Letter Ruling (PLR) in 2007 (PLR No. 200712013: http://www.exeter1031.com/1031_exchange_PLR_200712013.aspx) where they did allow a related party transaction via a reverse 1031 exchange.  You can click on the link to read the actual Private Letter Ruling issued by the IRS.

Yes, you would pay depreciation recapture taxes first and then capital gain taxes second only on the $20,000 different (boot).  There is nothing to worry about if the relinquished property sells for less because you have already reinvested $140,000.  It is only an issue if the relinquished property sells for more than what you have reinvested. 

Bill Exeter:

Option A: Forward 1031 Exchange with Related Party

Your wife is not a related party, but would be considered the same party since you are married and file a joint income tax return.  However, using an related entity that she owns can work.  It will depend on the related entity that is used to acquire your relinquished property.  The LLC owned 100% by your wife (related entity) WILL work IF she has elected to treat the LLC as a corporation for tax purposes (i.e. it is treated as a regarded entity and not a disregarded entity).  It WILL NOT work if the LLC is being treated as a single member LLC (a disregarded entity). 

My wife's company is registered as an S-Corporation with its own TaxID. Taxes have been filed for this company for the several(7) years now. She owns this company 100%.

I am assuming this would work.

Yes, as long as it is a "regarded entity" like a corporation, partnership or multiple member LLC it will work.  You just have to follow the related party rules.

Thanks Bill for all your help.

Now, going back to my original question on best option for me. Noting that I have the choice of selling this property to a "regarded entity" a S - Corporation owned by my wife and I will follow the related party rules. The related party rules indicates mainly that the corportation does not sell the property within the next 2 years.

Option A:  

Would forward exchange be better off by selling it to related party? This appears to be simpler and more straightforward. Hope "related party" does not create any red flags.

Option B:

Would Reverse exchange be better off, since this would involve an unrelated party? However, given the market conditions and it being a Condo, the chances of finding an unrelated party within 180 days is going to be hard. After this attempt, I do have the choice of selling it to the related party - a corporation owned by my wife.

It is kind of a hard decision. Hoping your experience in this area will help folks like us. Please let me know. Thanks again!

It is really a personal preference at this point.  My personal feeling is that I would prefer to avoid any related party dealings unless I absolutely have to.  It can always be the basis for further scrutiny, and I don't like to be "tied" up for two years.  I would structure it as a reverse 1031 exchange so that you have the best of both worlds.  You can try your best to sell to a non-related party and use your S corporation as a back-up in the event that you can not sell to a non-related party.  This gives you plenty of flexibility to go either way.