1031 Exchange Ownership Structures: LLC, TIC, DST, REIT & Same Taxpayer Rule Explained

The 1031 exchange ownership structures you choose for your investment property aren’t just a legal formality, they can determine whether you qualify for a 1031 exchange and how much flexibility you have when it’s time to sell

The entity through which you own a property could be a deciding factor in whether it’s possible to defer capital gains taxes through a like-kind exchange. Choosing the right 1031 exchange ownership structure is critical if your goal is long-term capital gains tax deferral.

What is a 1031 exchange, and why does ownership structure matter?

Section 1031 of the Internal Revenue Code outlines the rules for like-kind exchanges, which allow property owners to defer capital gains taxes on the sale of business or investment property if the proceeds are used to acquire a like-kind property. By putting off tax payments to a later date, exchangers can reinvest more capital into future properties, build greater wealth over time, and ultimately generate more tax revenue and economic activity.

A 1031 exchange can be performed by individuals and by entities such as LLCs and corporations, and properties can be owned outright or have a mortgage. Partnering with other investors can make it more feasible to own a property without debt, diversify into multiple property holdings, or upgrade to larger-scale properties and new sectors of real estate. But owning a property with multiple investors can complicate the 1031 exchange process due to something called the same taxpayer rule. Understanding how 1031 exchange ownership structures interact with this rule is essential before you buy or sell.

What is the same taxpayer rule in a 1031 exchange?

There are many rules that govern like-kind exchanges, including the 1031 exchange timeline and its 45-day identification deadline and 180-day closing deadline, as well as rules for foreign exchanges and those that involve related parties. One of the most important is the same taxpayer rule, which states that the taxpayer who owns the relinquished property must be the taxpayer to acquire the replacement property. The same taxpayer rule 1031 requirement is one of the most common reasons exchanges fail.

This means that if you own a property as an individual, you can’t exchange into a property held with others, and vice versa. Let’s say you own a single-family rental home and get the opportunity to partner with other investors on a large-scale industrial complex. You sell your rental property and use the sales proceeds to purchase the new property as part of a multi-member LLC. These transactions would not qualify as a like-kind exchange because the taxpayers were not the same: one was an individual and one was a multi-member LLC. This is a common issue in a multi-member LLC exchange where ownership changes before or during the transaction.

Or say you and a partner own a multifamily apartment building, and you both agree now is the time to sell. You want to use the proceeds to purchase a pair of single-family rental homes, but your partner doesn’t. You use your portion of the sales proceeds to purchase the homes with a bank loan, while your partner cashes out and pays the capital gains taxes. This also wouldn’t qualify for tax deferral because the relinquished property was sold by the partnership and the homes were bought by an individual. In contrast, a single-member LLC 1031 structure may offer more flexibility because it is typically treated as a disregarded entity for tax purposes.

Not all ownership structures are treated the same way when the IRS enforces the same taxpayer rule. For example, a Delaware Statutory Trust (DST) can involve hundreds of investors, but an individual interest in a DST is considered a single like-kind replacement property for 1031 exchange purposes. Understanding how your particular structure will be viewed is key to understanding what exchange options are available to you.

1031 exchange ownership structures: a comparison

Single-member 1031 exchange ownership structures

The simplest way to own property is to purchase it yourself, whether you’re buying in cash or with a mortgage. The downside is you’ll be limited as far as what you can afford, but the upside is you don’t have to worry about other investors dropping out or disagreeing on when to sell.

It is possible to utilize a corporate entity when owning a property yourself. For example, you could own a property through a single-member LLC where you are the sole member, and the LLC is not taxed separately. A single-member LLC 1031 exchange is generally treated the same as individual ownership for federal tax purposes. In this case, it could be possible to change entities without violating the same taxpayer rule. You could sell a property as an individual and buy as a single-member LLC, or sell as one single-member LLC and buy as another. The only stipulation is that both the sale and acquisition must be on the same tax return.

This flexibility means you can change your mind later as to the exact legal entity you wish to use and aren’t locked in to one ownership structure forever. But you will still be limited to properties that you as an individual can afford and manage yourself, unless you opt to exchange into a DST and give up the active management role. To scale up into larger commercial real estate and work with partners to manage those properties, a different kind of structure is required.

Multi-member ownership structures and 1031 exchanges

Just as an individual can own investment property, so can corporations and other legal entities. Setting up a corporate entity can allow you to partner with other investors. Doing so opens up possibilities when it comes to the types of properties available to you, but can have consequences when it’s time to split up. A multi-member LLC exchange requires careful planning to ensure all members intend to complete the like-kind exchange together.

Partnership, LLC and Corporation 1031 Exchanges

Working with a partner or small group of investors means you’ll be able to afford a wider range of properties, but the downside is that the more investors you have, the more likely it is that those investors might have conflicting goals, which is why planning around your exit and exchange strategy is so important.

A partnership interest cannot be used as a like-kind property under Section 1031. An exchange is only possible when the underlying properties are sold. And because the same taxpayer rule states that the taxpayer must remain consistent through both parts of the exchange, it’s not possible for only one person to exchange with their share of the sales proceeds. All members must agree to keep the legal entity intact throughout the 1031 exchange process. Because partnership interests themselves are not like-kind property, a multi-member LLC exchange must involve the underlying real estate rather than ownership units.

A multi-member LLC can be a good way to title an asset if the ownership group plans to stay together long-term and has similar goals. If not, you may be unable to complete your desired exchange because your partners may not want to sell or may wish to cash out and end the partnership.

In cases where the members of an LLC wish to go their separate ways upon sale, there are still options. You can organize a drop and swap, where one member exits the partnership and becomes a tenant in common with regards to the property. That person’s portion would be separated at closing, and they can perform an exchange if they wish. A drop and swap 1031 strategy allows one partner to drop into a tenancy-in-common 1031 structure before the sale, enabling separate like-kind exchange treatment. Drop and swaps are relatively new (considering like-kind 1031 exchanges have been around for more than a century), and enforcement of the rules governing them can vary by state.

Tenancy-in-Common (TIC) in 1031 exchanges

A tenancy-in-common (TIC) relationship gives property owners the ability to involve investors at different percentages, and to change those percentages at any time: one investor can buy out the others, an investor can exit and a new one can join, etc. Whereas with other structures, the departure of one investor would mean the property must be sold and legal entities changed, a TIC structure simplifies the process.

TIC is also useful for those who plan to hold property until their deaths, as the rules regarding survivorship and bequeathing an ownership stake are flexible when compared to joint tenancy, making TIC a useful component of a 1031 exchange estate planning strategy. A TIC relationship is a good idea for small groups of investors who wish to own a property together, but who may have different goals or plans regarding the future.

While TIC structures have become increasingly common in recent years, they are treated differently depending on which state you live in, and are given extra scrutiny when the exchange is ultimately analyzed on your tax return. Working with experienced 1031 exchange counsel is especially important with TIC structures.

Delaware Statutory Trust (DST) 1031 exchanges

A Delaware Statutory Trust (DST) allows for many investors to pool their funds for the purchase of a suite of large-scale commercial real estate. A DST 1031 exchange is structured to comply with IRS guidance that treats each investor’s beneficial interest as direct real estate ownership for like-kind exchange purposes. In addition to expanding the type, size, and number of properties that can be purchased, a DST has the added bonus of a sponsor that takes care of property management so investors don’t have to.

DSTs give each individual investor the freedom to make their own 1031 exchange decisions. While you can’t take your money out whenever you want (you’ll have to wait until the properties are sold or find a buyer on a secondary market), once the DST’s holding period ends, you can choose to perform an individual exchange, either by purchasing a whole property or investing in another DST. You don’t need to worry about what the other investors are doing, and you can participate in multiple DSTs simultaneously, increasing portfolio diversification.

Because DSTs are passive investments, they are a great option for those who previously held actively-managed property as individuals, but who now want to convert to more passive ownership as they enter retirement. DSTs can also simplify estate planning, so they are worth considering if you own a business or investment property and want to diversify while changing the level of control and management duties you perform.

Real Estate Investment Trust (REIT) and 1031 exchanges

Another popular way to invest in property is through a Real Estate Investment Trust (REIT). REITs differ from DSTs in that they are often publicly-traded and can be more easily bought or sold at any time. The downside of a REIT is that shares are not considered like-kind property for 1031 exchange purposes. That means that if you currently own shares in a REIT, you can’t defer taxes when you sell. A traditional REIT 1031 exchange is not permitted because REIT shares do not qualify as like-kind real property.

However, it is possible to go from a 1031 whole property exchange to a REIT through a Section 721 UPREIT exchange (Umbrella Partnership Real Estate Investment Trust). If your ultimate goal is to own shares in a REIT, you may not have to pay capital gains taxes first, though this method is limited in terms of options. For more information, read our blog on the subject.

Which ownership structure is best for a 1031 exchange?

The best 1031 exchange ownership structure depends on the asset you want to acquire, who you’re partnering with, and your long-term goals. For investors who already own business or investment property and hope to perform an exchange, it’s important to understand that no matter your current structure, it may be possible to perform a like-kind exchange down the road, provided you start early, make the right moves ahead of time, and get the right help.

Working with a Qualified Intermediary (QI) for complex 1031 exchanges

In addition to competent tax and legal counsel, your 1031 exchange will require a Qualified Intermediary (QI) to hold funds during the exchange. There are few requirements for who can act as a Qualified Intermediary, but if you have a complicated scenario like a drop and swap or an exchange involving a DST, you may find that many QIs don’t have the experience to meet your needs. Choosing a qualified intermediary experienced in multi-member LLC exchanges, DST 1031 exchanges, and complex ownership structures can help prevent costly compliance errors.

JTC’s team has decades of experience facilitating even the most complex 1031 exchanges. We work with all types of exchangers, from individual property owners to corporations, and all of our clients get access to the same rigorous fund security controls and use of our 24/7 online portal. When you’re ready to exchange, work with the QI that pioneered best practices for providing full transparency while keeping exchange funds secure.

Learn more about 1031 best practices