Trusts Partnerships and 1031 Exchanges

Trusts, Partnerships and 1031 Exchanges

One crucial aspect of real estate investing, especially for 1031 exchanges, is how property title is held. Understanding the ramifications of holding investment property in your name, jointly with others, in a trust, or in legal entities like LLCs, partnerships, or corporations, empowers investors to achieve their financial, estate, and tax planning goals more effectively.

Step-Up in Basis and Title Holding Methods: 

For many families, receiving a step-up in basis when an investment property passes to the next generation is paramount. While avoiding estate tax might sometimes outweigh the desire for a step-up in basis, most families we work with consider it an important estate planning strategy. To achieve this goal, it’s vital to know which title holding methods allow for a step-up in basis under established tax law. Irrevocable trusts, often created to move assets outside one’s estate for tax purposes, typically won’t enjoy a step-up in basis when the trust grantor passes away. Assets held in a typical revocable trust may provide a step-up in basis, depending on the trust’s language and whether you reside in a Community Property state.

Gifting Property and Its Consequences:

One of the biggest mistakes we’ve seen over the years involves gifting some or all of an investment property to adult children during the parent’s lifetime. This is sometimes done to simplify the eventual asset transfer or help the adult children during the parent’s lifetime. However, doing so might result in the current adjusted tax basis being transferred to the child who inherits the asset, eliminating their ability to claim a stepped-up cost basis when their parent passes.

Investor Independence and Title Holding:

Another important consideration for many co-investing investors is independence when the time comes to sell the property. Holding title to an investment property as Tenant in Common, for example, permits individual investors to act independently when the property sells. One investor might choose to cash out and invest the money, while another opts for a 1031 exchange to defer capital gains taxes. Holding that same property in an entity like an LLC, corporation, or partnership, however, may necessitate all members or partners to act in unison, making it difficult or even impossible for individuals to pursue a course that best meets their needs.

Legal Liability and Title Holding:

How title to a property is held can also affect legal liability. When a property is held in an LLC, Partnership, corporation, or certain trusts, there may be some element of liability protection afforded to those associated with the entity. However, legal requirements are associated with how these entities are structured and the activities of the involved individuals for the legal liability to be upheld. Generally speaking, holding title in your name directly or through a typical revocable living trust won’t provide any level of liability protection.

Accredited Investor Rules and Title Holding:

There’s also a difference between most entities, such as LLCs, Partnerships, Corporations, and irrevocable trusts, on one hand, and direct title and revocable trusts on the other, regarding the Securities and Exchange Commission’s rules related to Accredited Investor status. This is only relevant when a real estate investor is investing in securitized real estate investments. For an individual to invest in one of these structures, they must meet the individual Accredited Investor test. This means the investor has a net worth, excluding their primary residence, of at least one million dollars, or an annual income of $200,000, or $300,000 if married and investing jointly. However, if the investor is an entity like an LLC, Corporation, Partnership, irrevocable trust, etc., then the entity must have at least $5,000,000 in assets. In some cases, it may be possible to qualify as accredited if all members of the entity are individually accredited, but this is not always the case.

Conclusion:

When deciding how to hold title to a property or potentially changing your title holding method, considering the step-up in basis rules, the need for future investor independence, legal liability, and Accredited Investor rules are crucial aspects of the process. A simple conversation with qualified tax and legal professionals can save you a lot of trouble down the road.

Disclaimer: At 1031 Capital Solutions, we don’t give tax or legal advice, but we certainly can help point you in the right direction and may be able to identify issues you hadn’t considered.

This is for informational purposes only, does not constitute individual investment advice, and should not be relied upon as tax or legal advice. Please consult the appropriate professional regarding your individual circumstance. Statements concerning financial market trends are based on current market conditions, which will fluctuate. Past performance is not indicative of future results.

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