Can a Corporation Do a 1031 Exchange?

Yes. A C corporation or an S corporation can complete a 1031 exchange on real property it holds for investment or for use in its business. The corporation must be the seller of the old property and the buyer of the new one, and the usual 45 day and 180 day deadlines apply. What an exchange cannot do is move the property out of the corporation or let individual shareholders exchange their share. Getting real estate out of a corporation is generally a taxable event, whether or not an exchange has been done inside it.

Who can use Section 1031?

Section 1031 applies to taxpayers, and a corporation is a taxpayer in its own right. Individuals, partnerships, LLCs, trusts and corporations can all exchange real property, provided they follow the same core rules:

• ›The relinquished and replacement property are both real property held for investment or productive use in a trade or business
• ›The same taxpayer that sells is the taxpayer that buys
• ›A Qualified Intermediary holds the proceeds so the taxpayer does not receive them
• ›Replacement property is identified within 45 days and acquired within 180 days, or by the tax return due date if earlier

For a corporation, the same taxpayer rule usually means the replacement property is titled in the corporation's own name, under the same tax identification number that appeared on the sale.

How does an exchange work for a C corporation?

A C corporation pays tax on its own income, including gain on the sale of real estate. An exchange can defer that corporate level tax in the same way it defers tax for an individual. The deferred gain is carried into the basis of the replacement property, held inside the corporation.

The catch is the second layer of tax. Profits in a C corporation are generally taxed again when they reach shareholders as dividends or through a liquidation. A 1031 exchange inside the corporation does nothing about that second layer. It keeps the real estate in the company, which suits owners who intend to keep operating through the corporation, and does less for owners whose real goal is to get the property out.

Can a C corporation distribute the property and let shareholders exchange it?

Generally not without tax. When a corporation distributes appreciated property to its shareholders, the tax rules usually treat the corporation as if it had sold the property at fair market value. The corporation recognizes the gain, and the shareholders may then be taxed on the distribution as well. This is a key difference from partnerships, where a drop and swap is sometimes possible, although even there it raises holding period questions.

How does an exchange work for an S corporation?

An S corporation is generally a pass through entity. It does not usually pay federal income tax itself. Instead, gain flows through to the shareholders' returns. If the S corporation completes a valid exchange, the deferred gain is not passed through to shareholders in the year of the sale.

The exchange still has to be done by the S corporation. A shareholder who owns 40 percent of the company does not own 40 percent of the building, so that shareholder cannot sell "their share" of the property and exchange it individually. Selling shares of the corporation is a sale of stock, and stock is not like kind real property.

Distributions of appreciated property out of an S corporation are also generally treated as a sale at fair market value, with the gain passing through to all shareholders. As with a C corporation, taking real estate out of the company is usually a taxable event.

What about an S corporation that used to be a C corporation?

A corporation that converted from C to S status may be subject to a built in gains tax if it sells assets that were already appreciated at the time of conversion, during a recognition period after the election. A 1031 exchange can generally defer that tax as well, but the replacement property is generally treated as carrying the same built in gain. Timing and the exact calculation are technical, and your CPA should model them before a sale.

What happens when shareholders want different things?

This is the most common practical problem. One shareholder wants cash, another wants to keep deferring, and the corporation can only make one decision about its property. A corporation can do a partial exchange and keep some cash, but that cash is taxable boot to the corporation, and getting it to one shareholder rather than all of them raises its own tax questions.

Options such as redeeming a shareholder, dividing the business, or restructuring before a sale exist, but they are generally slow and carry their own tax consequences. They need planning months ahead, not in the middle of a 45 day identification period.

How do LLCs fit in?

It depends on how the LLC is taxed. A single member LLC is usually disregarded, so its owner is treated as the taxpayer. A multi member LLC is usually taxed as a partnership. An LLC that has elected to be taxed as a corporation is treated as a corporation for these purposes, and everything above applies to it. Changing an entity's tax classification during an exchange can break the same taxpayer rule, so most advisers suggest leaving the structure alone until the exchange has closed.

Practical steps for a corporate exchange

• ›Confirm the property is held for investment or business use, not as inventory for resale
• ›Have the board or shareholders authorise the sale, the exchange and the purchase in writing
• ›Make sure the exchange agreement, identification notice and closing documents are signed by an officer with authority to bind the corporation
• ›Title the replacement property in the corporation's exact legal name
• ›Ask your CPA how deferred gain and any boot will be reported on the corporate return

Can a corporation buy into a Delaware Statutory Trust?

A corporation can generally acquire a Delaware Statutory Trust interest as replacement property if it qualifies as an accredited investor, for example by meeting the asset test for entities, and if the offering permits entity investors. DST interests are securities, offered only through a licensed broker dealer and the definitive offering documents. They are illiquid, carry risk including loss of principal, and are not suitable for every investor.

The short version

A corporation can do a 1031 exchange, and it can be a sensible way to keep real estate working inside a company that intends to continue. It does not solve the tax cost of taking property out of a corporation, and it cannot be split among shareholders who want different outcomes. If your property is held in a corporation, talk with your CPA, attorney and Qualified Intermediary before you list it, while every option is still open.