Taxpayers often buy property using a limited liability company to avoid potential liability related to property ownership. When using a limited liability company the taxpayer does not own an interest in the property but owns an interest in the limited liability company instead.
The use of the limited liability company is an important distinction when the taxpayer is planning to structure a tax-deferred like-kind exchange.
Tax Deferred Like-Kind Exchanges and Limited Liability Companies
Buying property in a limited liability company can create problems when structuring tax-deferred like-kind exchange transactions when the limited liability company members all want to go different directions.
The taxpayer’s advisors must carefully analyze the tax-deferred like-kind exchange transaction to determine who owns the property and who will be completing the tax-deferred like-kind exchange.
Tax Deferred Like-Kind Exchange Options
The first and simplest option is to have the limited liability company sell the property and pay the proceeds to the members. The end result is that the members will pay income taxes on the sale of the property.
The second and easiest option in terms of structuring a tax-deferred like-kind exchange is to have the limited liability company complete the tax-deferred like-kind exchange within thelimited liability company. The limited liability company must stay together and no structural changes are needed in order to proceed with the tax-deferred like-kind exchange. The end result is that the income taxes are deferred within the limited liability company and the limited liability company continues operating.
The third option and probably most common scenario is where the limited liability company has multiple taxpayers that do not want to stay together. These limited liability companies are treated as partnerships. The taxpayer’s advisors must determine how to restructure the entity and/or parties involved in order to ultimately complete a tax-deferred like-kind exchange. Generally, the property is deeded out to the underlying taxpayers and then the transaction is completed in the future. This is referred to as a drop and swap structure.
The fourth and final option involves a limited liability company with multiple taxpayers that are willing to stay together for a relatively short period of time so that the tax-deferred like-kind exchange is completed at the limited liability company level and the property is distributed to the underlying partners after a certain amount of time. This is referred to as a swap and drop structure.
There are many variations to the strategies outlined above and depend on the taxpayers’ goals and objectives. It is important that taxpayer’s always seek legal, tax and financial advice prior to structuring any tax-deferred like-kind exchange.
Article by: William Exeter
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