Can an LLC Really Do a 1031 Exchange? Yes – But Don’t Make This Mistake + FAQs

Lana Dolyna, EA, CTC

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Can an LLC do a 1031 exchange? Yes. An LLC can perform a 1031 like-kind exchange, allowing it to defer capital gains taxes when selling and buying investment properties. Both single-member and multi-member LLCs are eligible, but the process comes with important rules and caveats.

A Limited Liability Company (LLC) can take advantage of Section 1031 of the Internal Revenue Code just like an individual or corporation can.

However, how the exchange is executed will depend on the LLC’s structure (single vs. multi-member) and tax status. Below we break down everything you need to know – from key IRS rules and definitions, to common mistakes to avoid, example scenarios, comparisons with other entities, and compliance tips – to ensure your LLC’s 1031 exchange is successful.

Key Terms & Definitions – Essential IRS Rules & LLC Structures

Understanding a 1031 exchange with an LLC requires familiarity with some key terms and IRS rules. Let’s clarify the essentials and how different LLC structures affect exchange eligibility:

1031 Exchange (Like-Kind Exchange): A 1031 exchange is a tax-deferral transaction that allows a taxpayer to sell investment or business property and buy a like-kind replacement property without immediately paying capital gains tax. Under IRC Section 1031, any realized gain is deferred (not forgiven) by reinvesting in similar property. Note that as of recent tax law, only real property (real estate) qualifies for 1031 exchanges (personal property no longer qualifies). The main benefits are deferring capital gains and potentially leveraging more capital into the new property.

Like-Kind Property: In real estate, “like-kind” is broad – almost any real estate held for investment or business use can be exchanged for any other real estate held for investment/business. For example, an apartment building can be exchanged for a retail center or vacant land. The property must be held for investment or productive use in a trade or business, not for personal use (so you generally cannot 1031 exchange a primary residence or property held as inventory/flips).

Limited Liability Company (LLC): An LLC is a legal business entity that provides liability protection to its owners (called members). For tax purposes, an LLC is very flexible: it can be treated as a disregarded entity, a partnership, or elect to be taxed as an S or C corporation. The default tax classification depends on the number of members:

A single-member LLC (SMLLC) is by default a disregarded entity for federal tax. This means the IRS “ignores” the LLC as separate from its owner. The LLC does not file a separate income tax return; its income and assets are reported on the owner’s tax return (e.g., on Schedule E or C for an individual).
A multi-member LLC (with 2 or more members) is by default treated as a partnership for tax purposes (unless it elects corporate taxation). A partnership files its own tax return (Form 1065) and issues K-1s to members. The LLC is considered a separate tax “person” from the members, even though profits/losses pass through to them.
An LLC of any size can also elect to be taxed as a corporation (C corporation or S corporation) by filing IRS Form 8832 or Form 2553. In that case, it’s no longer a pass-through; it becomes a separate corporate taxpayer. (This is less common for single-member LLCs unless they specifically want S-Corp status for self-employment tax reasons.)

Disregarded Entity: This term is crucial for 1031 exchanges. A disregarded entity is a business entity that is separate legally but ignored for tax purposes in favor of its owner. For example, a single-member LLC owned by an individual is a disregarded entity – the IRS treats the individual as the direct owner of the LLC’s assets. Why does this matter for 1031? Because one of the IRS’s key requirements is often called the “same taxpayer” rule or continuity of title rule. It means the taxpayer who sells the relinquished property must be the same taxpayer who buys the replacement property. With a disregarded LLC, the taxpayer is really the owner. This provides flexibility: an individual can sell an investment property in their own name and then take title to the replacement property in their single-member LLC’s name (for liability protection) without breaking the continuity requirement. The IRS sees it as the same person (the owner) continuing the investment, just using an LLC shell for legal ownership. Similarly, if a property is held in a single-member LLC, the owner could acquire the new property in their own name or another disregarded entity they own. In both cases, the taxpayer is the same individual behind the scenes.

Same Taxpayer Rule: Formally, the title on the replacement property should be held by the same party that held title to the relinquished property. For multi-member LLCs and other entities, that same party is the entity itself. For disregarded entities (like SMLLCs), the same party is the owner (since the entity is ignored for tax). There are exceptions to this rule allowed by IRS – notably single-member LLCs, revocable living trusts, and Delaware Statutory Trusts (DSTs) are recognized as disregarded, so changing between an individual and their single-member LLC or trust is permitted. Outside of those exceptions, changing who owns the property mid-exchange can disqualify the exchange.

Single-Member vs. Multi-Member LLCs: A single-member LLC (one owner) is usually the simplest for 1031 purposes. Because it’s disregarded (assuming no corporate election), the owner and the LLC are one and the same taxpayer. That means if you own a rental property and want to do a 1031 exchange, you could either keep it in your name or put it under a wholly-owned LLC – either way, the IRS treats you as the exchanger. You get the best of both worlds: full tax deferral eligibility and liability protection via the LLC. Many real estate investors hold each property in its own single-member LLC for risk protection; the good news is this doesn’t prevent 1031 treatment as long as the underlying owner (taxpayer) remains constant.

For a multi-member LLC (two or more members), the LLC itself is the taxpayer. The LLC can absolutely do a 1031 exchange – but the exchange must happen at the entity level, not the individual member level. The entire LLC sells the relinquished property and the entire LLC buys the replacement property. Individual membership interests in an LLC (or partnership) are NOT like-kind to real estate – in fact, the tax code explicitly excludes partnership interests from 1031 exchanges. This means a member can’t exchange their ownership units in the LLC for real estate. The property owned by the LLC must be exchanged for other property owned by the same LLC. If all members agree to continue their investment together into a new property, a multi-member LLC faces no issues doing a 1031 exchange. It’s only when some members want out (cash out and pay taxes) and others want to continue (defer taxes) that complications arise (we’ll cover those scenarios shortly).

Husband and Wife LLCs: A special note on husband-and-wife owned LLCs. If a married couple are the only members of an LLC, tax classification can depend on state law:

In community property states (e.g., California, Texas, Arizona, etc.), a husband and wife LLC can elect to be treated as a single-member (disregarded) entity for federal tax. Essentially, the couple is considered one economic unit. This is advantageous for 1031 exchanges because the IRS will treat both spouses together as the single “taxpayer” behind the LLC, simplifying the exchange process.
In non-community property states, a married couple’s two-member LLC by default is a partnership for tax purposes (two owners). They would either need to accept partnership treatment or put the property in one spouse’s single-member LLC (or both form separate single-member LLCs for respective halves) if they want disregarded treatment. The key is to know how your husband-wife LLC is classified so you follow the correct approach in the exchange.

Qualified Intermediary (QI): Regardless of entity type, using a Qualified Intermediary is a must for any 1031 exchange. A QI is a neutral third party that facilitates the exchange – they hold the sale proceeds and reinvest them into the replacement property for you. Neither an LLC nor an individual can take possession of the cash from the sale; if you do, the IRS will deem it a taxable sale (breaking the exchange). So an LLC doing a 1031 must hire a QI just as an individual would. The QI prepares exchange documents in the name of the LLC (or the appropriate taxpayer) and ensures funds are properly escrowed to preserve the tax-deferred status.

Timeline Rules: The standard 1031 deadlines apply to LLCs as well:

45-Day Identification Period: From the closing of the sale of the relinquished property, the entity (LLC or owner) has 45 days to formally identify potential replacement property(s) in writing. This is a strict deadline.
180-Day Exchange Period: The purchase of the replacement property must be completed within 180 days from the sale (or by the tax return due date, whichever is earlier). This typically gives about 6 months to close on the new acquisition. Failing either of these deadlines will cause the exchange to fail, so careful planning and timing are crucial.

“Boot” (Taxable Proceeds): If the exchange is not fully equal or greater in value, any leftover cash or debt reduction (known as boot) will be taxable. For instance, if an LLC sells a property for $1,000,000 and only reinvests $900,000 into replacement property, the $100,000 difference is taxable gain. LLCs should be mindful of reinvesting the full sales proceeds and obtaining equal or greater financing on the new property (if the old property had a mortgage) to fully defer taxes. Boot can also inadvertently occur if, say, one member of an LLC takes cash out while the rest reinvest – that member’s portion would be taxable.

Now that we’ve covered the terminology and ground rules, let’s see how these play out in practice for single-member and multi-member LLCs.

LLC Structure and 1031 Eligibility – At a Glance (Table)

To clarify how different LLC setups impact 1031 exchange treatment, the table below summarizes common structures:

LLC Structure	Tax Classification	1031 Exchange Eligibility	Key Considerations
Single-Member LLC (one owner, default tax status)	Disregarded entity (owner is taxed on LLC income)	Yes – Treated as the same taxpayer as the owner.	Simplest case. The owner can sell in their name and buy in LLC’s name (or vice versa) without issue. Must not elect corporate tax status if you want disregarded treatment.
Single-Member LLC (elected S-Corp or C-Corp)	Separate corporate entity (S corp or C corp)	Yes – The LLC (corporation) itself must do the exchange.	The owner and LLC are distinct taxpayers for IRS. The property must be sold and bought by the LLC entity. No switching into the owner’s name because it’s not disregarded.
Multi-Member LLC (default partnership)	Partnership (pass-through entity filing Form 1065)	Yes – The LLC partnership can exchange property it owns.	All members must participate as one entity. Individual membership interests cannot be exchanged. If some members want out, consider a drop-and-swap strategy. Keep ownership continuous during exchange.
Multi-Member LLC (elected Corporation)	Corporation (taxed as C or S corp)	Yes – The LLC (as a corporation) exchanges as one taxpayer.	Similar to a regular corporation doing a 1031. The entity is separate from owners. Shareholders can’t exchange shares for property. All activity stays in the entity’s name.
Husband & Wife LLC (Community Property State)	Can be treated as disregarded (single taxpayer) by IRS if spouses elect	Yes – Can be viewed as a single owner for exchange purposes.	Only available in community property jurisdictions. If treated as one tax unit, works like a single-member LLC (simplifies exchange). If not, default is partnership (then treat as multi-member rules).
Husband & Wife LLC (Non-Community State)	Partnership by default (two members)	Yes – but as a partnership entity for the exchange.	Not automatically disregarded. Both spouses’ LLC must do the exchange together (or put property in one spouse’s name/LLC beforehand to simplify). Plan ahead if you prefer single ownership for exchange.

Note: Trusts and other entities can also be disregarded. For example, a revocable living trust is often treated as a disregarded entity (grantor trust) for a 1031, meaning the individual grantor is the taxpayer. Likewise, a Delaware Statutory Trust (DST) can qualify as a like-kind replacement in certain cases. The principles for LLCs often parallel those for these other entities in terms of needing the same taxpayer continuity.

Mistakes to Avoid – Pitfalls That Can Disqualify an Exchange

A 1031 exchange is a powerful tax tool, but it’s easy to make a misstep that nullifies the tax deferral. When using an LLC, you need to be extra mindful of certain pitfalls. Here are some common mistakes and risks to avoid:

Mixing Up the “Taxpayer” on Title: One of the biggest mistakes is failing to maintain the same ownership from sale to purchase. For instance, selling a property in your personal name and trying to buy the replacement under a new multi-member LLC (with additional partners) will break the exchange. The buyer (taxpayer) isn’t the same as the seller. Always ensure the entity or person that relinquishes property is the one that acquires the new property. If you need to change how title is held (e.g., move into an LLC for liability reasons), do it with a disregarded entity or plan it outside the exchange timeline. Avoid changing members or ownership percentage during the exchange process. Any ownership change can jeopardize the “same taxpayer” requirement.
Attempting to 1031 Exchange an LLC Interest: Remember, a membership interest in an LLC is personal property, not real estate. Swapping an interest in a partnership or LLC for real estate (or another partnership interest) is not allowed. Some investors mistakenly think they can trade their share of an LLC for a piece of a property – you can’t under Section 1031. The exchange has to involve actual real estate owned by the LLC (or individual), not the paper ownership units of an entity. If you want to separate ownership, you must convert that interest into a direct property interest (e.g., via a drop-and-swap) before or as part of the sale.
Partners Going Separate Ways Without Planning: If you’re in a multi-member LLC and not all members want to roll into the next property, failing to plan is a recipe for trouble. All too often, partners realize at sale time that one partner wants to cash out. If the LLC simply sells and distributes cash to that partner, the exchange is broken for everyone. To avoid this, plan a “Drop and Swap” ahead of time (more on this in the examples section). Essentially, those who want out should receive their share as a tenant-in-common interest in the property before the sale (the “drop”), so they can sell their portion for cash (paying tax) while the LLC (or remaining members) exchange their portion. Doing this last-minute or incorrectly can be risky. Work with your attorney and tax advisor well in advance if a split is expected. The IRS could scrutinize a drop-and-swap done just days before closing, so timing and intent matter.
Missing 45-Day or 180-Day Deadlines: This mistake isn’t unique to LLCs, but it’s worth emphasizing. The clock starts the day you close on the sale. If your LLC fails to identify replacement properties by day 45, or fails to close on a replacement by day 180, the exchange fails entirely. Mark these deadlines and have a strategy to meet them (e.g., identifying backup properties, securing financing early). Extensions are generally not granted except in rare disaster-related circumstances.
Not Using a Qualified Intermediary (QI) or Using a Disqualified Intermediary: As mentioned, the LLC cannot take possession of sale proceeds. Some may think having the money pass through an LLC’s bank account is okay – it isn’t. The IRS will consider that receipt of funds (taxable). You must use a qualified intermediary to hold the funds. Also be careful not to use a disqualified person as the QI (for example, a member of the LLC, or the LLC’s attorney or broker who has been your agent recently, cannot serve as the intermediary). Always hire a reputable independent QI to handle the exchange process.
Electing the Wrong Tax Status at the Wrong Time: If you intend to treat a single-member LLC as a disregarded entity for your exchange, make sure you haven’t filed any paperwork to change its classification. For example, filing Form 8832 to elect corporate taxation could inadvertently take your LLC out of disregarded status, complicating the exchange. Similarly, if you want an LLC to be treated as a partnership, don’t file any elections that would contradict that before the exchange. Know your entity’s tax status and keep it consistent through the exchange period.
Changing Ownership Too Soon After the Exchange: Even after a successful exchange, be cautious about making immediate changes. If your LLC completes a 1031 exchange and then shortly afterward you dissolve the LLC or transfer the new property to different owners, the IRS might question whether the exchange was done in good faith. For instance, adding a new member to the LLC right after acquiring the replacement property could be seen as that new member indirectly swapping into the deal (which wasn’t allowed). A good practice is to hold the replacement property in the same entity for a prudent period (often advised at least one to two years) before making significant ownership changes. This helps demonstrate the property was “held for investment” by the exchanging entity, not just briefly parked.
Failing to Consult Professionals: 1031 exchanges, especially involving entities, can get complex. Not getting advice from a tax advisor or real estate attorney experienced in 1031s can lead to oversights. For example, state laws (like community property rules or property transfer taxes) can affect how you structure the exchange with your LLC. A qualified CPA or attorney can guide how to execute a drop-and-swap properly, how to document the transactions, and ensure compliance with both IRS rules and state regulations. Skimping on professional guidance to save costs can result in a much more expensive tax bill if the exchange fails.

Avoiding these mistakes will greatly increase the odds that your LLC’s 1031 exchange goes through without a hitch. Next, let’s look at some scenarios illustrating how single-member and multi-member LLCs navigate 1031 exchanges.

Example Scenarios – How LLCs Handle a 1031 Exchange

To make these concepts more concrete, here are a few example scenarios demonstrating how 1031 exchanges work for LLCs in real-world situations:

Example 1: Individual to Single-Member LLC Exchange

Scenario: John owns a rental property in his personal name and wants to sell it and buy a bigger investment property. He also wants the liability protection of an LLC for the new property.

Approach: John can set up “John Investments LLC” as a single-member LLC, with himself as the sole owner. He sells his rental property (which was titled in John’s name) using a 1031 exchange. When purchasing the replacement property, he takes title under John Investments LLC.

Outcome: The IRS sees no taxpayer change here. John, as an individual, sold the old property, and John (through his disregarded LLC) bought the new property. Because the LLC is disregarded, it’s treated as if John bought the property himself. The exchange is valid. John effectively deferred all his capital gains tax, and now the new property is owned by his LLC, giving him personal liability protection moving forward.

Key point: Using a single-member LLC didn’t impede the exchange at all. John just needed to ensure the exchange paperwork and deed reflected the right names (often the deed will read “John Investments LLC, as 100% disregarded entity of John Doe”). By coordinating with his Qualified Intermediary and attorney, this was handled seamlessly. He also made sure not to add any other members to the LLC during the process. Later on, if John wanted to bring in a partner, he should wait a reasonable time or understand that doing so could have tax implications going forward (but it wouldn’t retroactively break his completed exchange).

Example 2: Multi-Member LLC – All Members Reinvest Together

Scenario: ABC Holdings LLC has two members, Alice and Bob, who each own 50%. The LLC owns a small apartment building (held for many years as an investment). Alice and Bob decide to sell the building and use a 1031 exchange to buy a larger apartment complex. Both want to continue as co-owners; neither plans to cash out.

Approach: The sale of the apartment building is done in the name of ABC Holdings LLC. The LLC enters into an exchange agreement with a Qualified Intermediary, and the sale proceeds go into the QI’s escrow account. Within 45 days, Alice and Bob (through the LLC) identify a suitable replacement property – a larger complex. The LLC then uses the escrowed funds (plus additional cash and financing as needed) to purchase the new property, with title taken under ABC Holdings LLC again.

Outcome: The entire transaction occurred within the LLC, which is the same taxpayer throughout. Alice and Bob’s LLC sold property and the same LLC bought property. They deferred the capital gains tax on the sale entirely. On their personal taxes, Alice and Bob will each get a K-1 showing no taxable gain from the sale (since it was deferred), and going forward they’ll each be allocated their share of income from the new property. This scenario is straightforward because there were no changes in ownership or structure. Alice and Bob maintained the status quo of the LLC during the exchange – the IRS’s continuity requirement is satisfied. Essentially, nothing changed except the property the LLC owns.

Key point: In a multi-member LLC where everyone is on board with reinvesting, a 1031 exchange is very feasible. The LLC just acts like any other investor performing an exchange. The members should ensure that the LLC agreement and any lender involved allow for the transaction (some operating agreements require member consent to sell or purchase property – which they have – and lenders might require notification or approvals when replacing collateral). As long as all members stick together, the 1031 process for an LLC is as smooth as for an individual.

Example 3: Multi-Member LLC – Partners Parting Ways (“Drop and Swap”)

Scenario: Three friends own a commercial property via XYZ LLC (each owning 1/3 interest). The property has appreciated significantly. Now, two of the members (let’s call them Karen and Leo) want to buy a new property and keep deferring taxes, but the third member (Mike) wants to cash out and use his share of money for something else. How can they do a 1031 exchange if one partner doesn’t want to reinvest?

Problem: If XYZ LLC sells the property and simply distributes Mike’s 1/3 share to him in cash while Karen and Leo attempt to reinvest the other 2/3 via the LLC, the exchange won’t fully qualify. Mike’s distribution would be considered a taxable sale of his partnership interest (not exchangeable), and even Karen and Leo’s part could be at risk because the LLC as a whole didn’t reinvest all proceeds (also the LLC’s ownership changed when Mike left). This scenario needs careful handling.

Approach (Drop and Swap Solution): Before selling the property, XYZ LLC executes a “drop” of ownership to the members as tenants-in-common. In practice, the LLC would distribute fractional title to the property to the members according to their shares (each now holds an undivided 1/3 interest in the real estate directly). This dissolves XYZ LLC’s ownership of the property; instead Karen, Leo, and Mike individually hold title as co-owners (tenant-in-common, or TIC). Now they proceed to sell the property: each co-owner will effectively be selling their own share.

Karen and Leo each intend to do a 1031 exchange with their portion of the sale proceeds.
Mike will simply sell his share for cash (and pay taxes on his gain).

At closing, the Qualified Intermediary is set up to handle Karen and Leo’s two-thirds of the proceeds, while Mike’s one-third goes to him outright. Karen and Leo then identify and purchase a new replacement property together. They could either form a new LLC for the new property or continue as tenants-in-common on the new property – but importantly, they do not include Mike. Mike is out, and the new investment is only for Karen and Leo.

Outcome: Karen and Leo successfully defer taxes on their shares by acquiring a new investment (they might form a new LLC to hold it, with just the two of them as members, for liability protection – that new LLC would be a partnership of two, but since the exchange was done via their TIC interests, it’s fine). Mike receives cash for his share and will owe capital gains tax on his one-third of the sale. The “drop and swap” allowed the separating of interests so that the continuing investors could use 1031, and the exiting investor simply took his taxable proceeds.

Key point: Timing and documentation are critical. Ideally, the drop to TIC ownership should be done before a buyer is lined up, to show that each member held their interest directly for a period (demonstrating an investment intent, not just an immediate resale). In practice, many do the drop just prior to sale – it can work, but the IRS has at times challenged exchanges if the drop appears too abrupt or solely for tax avoidance. To be safer, some might complete the exchange first with the LLC (“swap”), and then later “drop” the interest to the departing partner by distributing a tenancy-in-common interest in the replacement property to them (this is sometimes called a “swap and drop”). Both methods have risks if done in quick succession. Expert guidance is a must.

The bottom line: A multi-member LLC can accommodate members with different goals, but it requires extra steps. The exchange can be structured so the continuing members defer tax and the others cash out, but it’s not as straightforward as a unanimous exchange. This example underscores why all LLC members should discuss plans well before selling an appreciated property.

These scenarios show that whether you have a single-member LLC or a complex partnership LLC, 1031 exchanges are achievable. The key is maintaining the proper taxpayer through the deal and using strategies like disregarded entities or drop-and-swap when needed. Next, we’ll compare LLCs to other entity types in the context of 1031 exchanges to see how they stack up.

Comparison to Other Entities – How LLCs Differ from Corporations & Partnerships

Can other types of business entities do a 1031 exchange? Yes – individuals, partnerships, corporations (C or S), trusts, and more can all potentially use 1031 exchanges for real estate. The rules of “same taxpayer” and like-kind property apply universally. The differences lie in how ownership is structured and what flexibility each type has. Here’s how LLCs compare to other entities regarding 1031 eligibility:

LLC vs. Individual: An individual real estate owner is the simplest case for 1031 exchanges – the person sells investment property and buys another in their own name. An LLC doesn’t inherently gain any special tax advantage in an exchange over an individual; the main reason to use an LLC is legal protection or co-ownership management. A single-member LLC essentially is the individual for tax purposes, so it’s almost equivalent to the individual doing the exchange (with the added benefit of liability protection). An individual can also be more flexible after an exchange – since they directly own the replacement property, they can later decide to transfer it into an LLC (though should wait a bit to satisfy “held for investment” criteria). Conversely, if the property was initially in an LLC and you want to take personal ownership after the exchange, you’d also wait and then liquidate the LLC or distribute the property to yourself (keeping in mind potential state tax or legal consequences). The key difference is not in tax treatment (since a single-member LLC is the same as individual) but in procedure – with an LLC you must ensure titles and identification are done in the entity’s name or vice versa appropriately.
LLC vs. General Partnership/Limited Partnership: A multi-member LLC taxed as a partnership is essentially the same scenario as a traditional partnership or limited partnership owning real estate. In all these cases, the partnership entity must execute the 1031 exchange, and partners cannot individually exchange out their partnership interests. The LLC form is just a more modern, flexible vehicle for partnerships compared to a limited partnership, but the IRS treats them similarly for 1031. One minor difference: partnerships (including multi-member LLCs) often face the drop-and-swap issue if not all partners agree on an exchange. Some partnerships pre-empt this by not holding property in the partnership at all; instead, each partner holds a percentage as tenants-in-common from the start. By doing that, each partner is technically an individual owner (so each can do their own 1031 or sell independently). However, TIC arrangements have their own complexities and are not “entities” per se. Within an LLC partnership, the operating agreement might also restrict transfers, which can complicate splitting up before an exchange. In any case, LLC or LP, the same challenge exists: you must move the ownership out of the entity form if partners want different outcomes.
LLC vs. S Corporation: An S corp is a pass-through entity like a partnership (no corporate tax), but it’s a corporation for legal purposes. If an LLC elects to be taxed as an S corp, or if you have a standard S corporation owning property, the exchange works similarly: the corporation must be the one doing the exchange. Shareholders of a corporation cannot individually exchange their stock for real estate. Also, a single-shareholder S corp does not enjoy the disregarded entity status – even one owner is separate from the corporation for tax. This is a slight downside compared to an SMLLC: if you hold property in a one-owner S corp and you want to do a 1031, you don’t have the option of switching into your personal name or a disregarded LLC; the exchange must stay in the S corp. Another nuance: S corps have restrictions on who can be shareholders and cannot easily change ownership percentages without potentially invalidating S status (if it results in a second class of stock issue). So bringing in a new investor around an exchange has to be done carefully. LLCs are generally more flexible entity-wise. Tax-wise, though, an S corp and a multi-member LLC (partnership) both pass the tax through and can perform exchanges at the entity level.
LLC vs. C Corporation: A C corporation is a separate taxable entity. Any gains or losses belong to the corporation, and any 1031 exchange would be done by the corporation. The same issue as S corp – shareholders can’t directly do anything – applies. One notable aspect: C corps pay their own tax (at corporate rates) and there’s no pass-through. But if a C corp does a 1031 exchange, it defers its corporate-level tax on the gain. LLCs have an edge in that they avoid double taxation; however, in a 1031 context, if the plan is to continually defer and eventually maybe step-up basis at death, a C corp’s double tax might never actually come into play on sale – but it could if the corporation liquidates later. In practice, it’s rarer for individuals to hold real estate in a C corp nowadays due to tax inefficiency and lack of flexibility. LLCs (either disregarded or partnership) are usually preferred for real estate holdings for these reasons. The 1031 rules themselves apply equally to any “taxpaying person,” which includes a corporation or an LLC, so eligibility is not a problem for a corporation-owned property; it’s more a matter of flexibility and eventual exit strategy.
LLC vs. Trusts: Trusts often hold real estate too. A revocable living trust (grantor trust) is disregarded for tax (the grantor is the taxpayer), so doing a 1031 with a revocable trust is similar to a single-member LLC scenario – the trust can sell and the individual grantor can acquire replacement (or vice versa) because it’s the same taxpayer. An irrevocable trust is typically its own taxpayer (with its own EIN). If an irrevocable trust owns property, the trust itself must do the 1031 exchange and remain the owner of the replacement property; the beneficiaries can’t swap their beneficial interests for real estate (just like partnership interests can’t be swapped). An LLC is different in that the members could dissolve the LLC and take direct title if needed, whereas with some irrevocable trusts it’s not so simple to change ownership (without court or trustee actions). But otherwise, conceptually, a non-disregarded trust is analogous to an LLC or corporation doing the exchange – the entity/trust is the exchanger.
LLC vs. Delaware Statutory Trust (DST): A DST is a unique entity often used in 1031 exchanges as replacement property. The IRS treats certain DST interests as if they were direct ownership of real estate (similar to TIC) under Revenue Ruling 2004-86. Investors can exchange into a DST to own a fractional share of a larger property (common in securitized real estate deals). Why mention DST here? Because DSTs are sometimes an alternative to the drop-and-swap for multiple owners. If an LLC with multiple members wants to sell and not all want active management of a new property, they might all exchange into a DST where each one holds a beneficial interest that suits their investment goals (some might later cash out by selling their DST interest, others hold long-term). An LLC can’t directly exchange into a DST interest (since the DST interest is considered real estate ownership by the beneficial owners, not by the old LLC entity – the LLC would likely have to dissolve into individual owners who then take the DST interests). LLCs and DSTs are related in that DSTs provide a way for multiple investors to own property without a partnership. Comparatively, an LLC is easier for a small group to manage property directly, but if that group can’t stay together for a 1031, a DST or TIC structure might be considered next time.

In summary, LLCs are as eligible for 1031 exchanges as any other business or individual, but they offer a blend of flexibility and complexity. Single-member LLCs mimic individuals (very flexible for exchange structuring), while multi-member LLCs mimic partnerships (requiring unity or creative planning for splits). Unlike corporations, LLCs can choose to be disregarded or pass-through, giving more options in how to comply with 1031 rules. The main thread across all entities is the same: the entity that realizes the gain must acquire the replacement. LLCs just have the unique ability to sometimes be “looked through” to an owner, which others (except grantor trusts) do not.

IRS Scrutiny & Compliance – How to Ensure a Successful Exchange

The IRS pays close attention to 1031 exchanges due to the potential for abuse or mistakes. To ensure your LLC’s exchange withstands scrutiny, you must follow the rules diligently and document everything. Here are compliance tips and areas where the IRS will be looking:

Same Taxpayer Consistency: We’ve hammered this point because the IRS does too. They will verify that the taxpayer ID (SSN or EIN) that sold the relinquished property is the same as the one buying the replacement. If your single-member LLC uses your SSN (disregarded), and you buy the new property in that LLC’s name, that’s fine – the tax return will show it was you. If you had a multi-member LLC (with its own EIN), the new property better be under that same LLC’s EIN. Any discrepancy will raise a red flag. So ensure the closing documents, title reports, and exchange agreement all align on the correct name. If you plan to use a disregarded entity, inform the QI early so they can prepare assignment documents that swap the rights to the new LLC or trust while preserving the exchange structure.
Documentation of “Drop and Swap” Steps: If you do a drop-and-swap or any pre-exchange restructuring, keep thorough documentation. For example, if your LLC transferred deeds to members (to become TIC owners), have written resolutions, updated title records, and maybe separate escrow for each owner’s share. You want to show that the entity truly relinquished its interest before the sale. The IRS may ask: was the property truly held by the individuals as an investment (even if briefly) or was this just a sham transaction? One way to support your case is showing that the decision to drop to TIC was made for valid business reasons and that each co-owner bore the benefits and burdens of ownership (e.g., maybe each started marketing their share or entered separate contract agreements with the buyer). This is technical, but an experienced real estate attorney can help create the paper trail to defend the exchange if audited.
Intention and Holding Period: The IRS might scrutinize how long the relinquished property and replacement property were held, especially around changes in ownership. There’s no strict holding period rule in the statute, but case law has shown that quick turnarounds can be problematic. If your LLC bought a property and is trying to exchange it within a few months, the IRS could argue it wasn’t “held for investment” but rather for resale (which doesn’t qualify). Similarly, if you drop members in or out just to do the exchange and they didn’t hold their interest for at least some time, that could be challenged. To be safe, many tax advisors suggest holding property for at least a year (to cross into a new tax year, ideally) before doing a 1031 exchange, and likewise holding the replacement for a substantial period. While this is not a black-and-white rule, it demonstrates investment intent. So plan your exchanges as part of a long-term strategy, not a quick flip tactic.
Use of Proper Forms: After the exchange, make sure the right tax forms are filed. For any 1031 exchange, the taxpayer (individual, LLC, corporation, etc.) must file IRS Form 8824 (Like-Kind Exchanges) with their tax return for the year of the exchange. This form reports the details of the exchange, even if no gain is recognized. If your LLC is a partnership, the Form 8824 is filed with the partnership return (Form 1065), and information also flows to each partner’s K-1. If the LLC is disregarded, you (the owner) file Form 8824 with your individual 1040. Ensuring the form is correctly completed and matches what happened is critical. Any inconsistencies (like indicating the wrong taxpayer name or listing cash received that wasn’t actually received by that taxpayer) can invite questions.
Avoiding “Abusive” Transactions: The IRS has flagged certain 1031 exchange practices as potentially abusive. One example is related to drop-and-swap – if they see a pattern of an LLC dropping partners just before an exchange repeatedly, they might challenge the legitimacy, calling it a step transaction to avoid the partnership interest rule. Another example is using passthrough entities in convoluted ways to try to swap properties that aren’t truly like-kind or to accommodate personal-use property. Always align with the intent of Section 1031: it’s meant for genuine reinvestment in business or investment real estate. If something feels like a loophole or too good to be true, double-check against IRS guidance or rulings.
Consultation and Advance Rulings: If you have a particularly complex situation (say, multiple entity layers, international issues, etc.), consult with a tax professional. In rare cases, taxpayers can seek a Private Letter Ruling from the IRS for clarity on a proposed transaction (though this is expensive and time-consuming). For most, simply following known IRS rulings and tax court cases is sufficient. We discussed earlier IRS Revenue Rulings 99-5 and 99-6, which provide guidance on situations where a single-member LLC turns into a partnership or vice versa as part of a transaction. Those rulings essentially allow certain exchanges when buying into or out of an LLC in a way that either creates or dissolves the partnership. Make sure your advisors are aware of these if your deal is similar, as they can help structure it in compliance with IRS precedent.
State Compliance: Don’t forget state tax rules. Most states follow federal 1031 treatment, but some do not allow state-level deferral. Also, transferring property into or out of an LLC might trigger transfer taxes or reassessment of property tax under state/local law. For example, in California, adding a new member to an LLC that owns real estate can trigger a property tax reassessment unless carefully structured. While this isn’t an IRS issue, it’s part of compliance and cost consideration. Ensuring all steps are legal and properly recorded at the state level will complement your IRS compliance.

In essence, to satisfy the IRS, you want your 1031 exchange involving an LLC to look clean and by-the-book: the same economic party gave up property and received property of equal or greater value, with no profit-taking in between. Any deviations (like partial cash-outs or ownership shuffles) should be minimized and justified. Keep your records, work with knowledgeable professionals, and follow the timelines. When done correctly, an LLC’s 1031 exchange can withstand IRS scrutiny and deliver significant tax savings legally.

FAQs – Common Questions on LLCs and 1031 Exchanges

Can a single-member LLC do a 1031 exchange?
Yes. A single-member LLC is a disregarded entity for tax purposes, so the owner is treated as the exchanger. It can sell and buy investment property and defer taxes via 1031.

Can a multi-member LLC do a 1031 exchange?
Yes. A multi-member LLC (taxed as a partnership or corporation) can perform a 1031 exchange at the entity level. All members must participate as one taxpayer through the LLC for a successful exchange.

Do all LLC members have to reinvest in a 1031 exchange?
Yes, if the property is owned by a multi-member LLC. The LLC must reinvest as a whole. Individual members can’t opt out of the exchange unless the ownership is restructured (e.g., drop and swap) beforehand.

Are LLC membership interests eligible for 1031 exchange?
No. An LLC membership interest is not considered like-kind to real estate. You cannot exchange an ownership interest in an LLC for property. The LLC must sell the real estate it owns and buy new real estate.

What is a disregarded entity in a 1031 exchange?
It’s an entity the IRS ignores for tax purposes (like a single-member LLC or revocable trust). The owner is treated as the direct taxpayer. Disregarded entities let you change legal title (to/from an LLC) without breaking 1031 rules.

Can I sell a property personally and buy the replacement in an LLC?
Yes, if the LLC is a single-member LLC you own (disregarded). That’s treated as the same taxpayer. But if you buy in a multi-member LLC that’s different (new taxpayer), it would not qualify without special planning.

Does an LLC need a Qualified Intermediary for a 1031 exchange?
Yes. An LLC must use a Qualified Intermediary just like any individual would. The QI holds the funds between sale and purchase. Having the LLC receive the funds directly will disqualify the exchange.

Can a husband and wife LLC do a 1031 exchange?
Yes. If in a community property state and treated as a single taxpayer, it’s as easy as a single-member LLC exchange. In other cases, the husband-wife LLC (as a partnership) can still do an exchange together at the entity level.

What happens if one LLC member wants cash and others want to 1031?
The members should execute a drop-and-swap. The member wanting cash can take a direct ownership share of the property and sell it (paying tax), while the LLC (or remaining members) exchanges their share and defers tax.

Is there a minimum holding period for an LLC’s property before 1031 exchange?
No fixed period by law, but the property must be held for investment, not resale. Often a holding period of at least one year is recommended to demonstrate intent and avoid IRS challenges.