Vesting Issues
For an exchange to satisfy IRC §1031, the taxpayer(s) vested on title that sold the relinquished property must be the same taxpayer(s) that are vested and hold title to the Replacement Property purchased as part of an exchange. However, lender requirements, estate planning needs, liability issues, and other unforeseen matters may make it challenging for the Exchanger to maintain the same vesting on the Replacement Property as was on the Relinquished Property. Exchangers must anticipate these vesting issues as part of their advanced planning for the exchange, as changing vesting too close to the sale (or purchase in the case of a Reverse Exchange) could cause a partial or even full recognition of gain on behalf of the original selling taxpayer.
To avoid any potential disqualification in full or in part, no changes in vesting should occur just before or during an exchange. If not absolutely necessary during the exchange, it is safest to not make any last-minute changes to vesting.There are some exceptions to this rule when dealing with entities that are disregarded for federal income tax purposes and individuals residing in Community Property States who hold the property as "Community Property". For example, the following changes in vesting usually do not degrade the integrity of the exchange:
(Only in Community Property States) A husband who holds title to a Relinquished property individually as Community Property may purchase Replacement Property as Husband and Wife as Community Property or in an LLC where husband and wife are the sole members with interests held as Community Property and the LLC is a disregarded entity
In the event of a death during the exchange, the Exchanger's estate may complete the exchange after the Exchanger dies following the close of the sale of Relinquished Property. Revenue Ruling 64-161
The Exchanger may sell a Relinquished Property held individually and acquire Replacement Property titled in a single-member LLC or acquire multiple Replacement Properties in different single-member LLCs, as long as the Exchanger is the only member, and the single member LLCs are treated as disregarded entities. Private Letter Ruling 200732012
Changing vesting during an exchange, such as when the Relinquished Property is owned by one spouse and the Replacement Property will be acquired by both spouses, could result in partial or even full recognition of gain by the entity/taxpayer/spouse on title to the Relinquished Property.
Lender Issues Causing a Change in Vesting
In some cases, when the situation causing a change in vesting is due to lender requirements for the loan needing a spouse added to title for the purpose of acquiring debt, they may want to consider either:
Providing the Qualified Intermediary and their CPA written notice from the lender of such a requirement, or
Preparing a simple trust to show that the spouse is being added to title due to the lender's requirement, but as between them, the added spouse is holding their share "in trust" for the benefit of the spouse already on title
Please review with your tax advisors for clarification and any additional documentation they may desire in your file in the event it is questioned by the service.
