Can a Trust Do a 1031 Exchange? Exchanging Property Held in Trust

More and more New York landlords put their rental properties in trusts to avoid probate later (see our “New York Trust Series”). That raises the question: can property held in a trust be exchanged under Section 1031, and can the replacement go straight into the trust? The answer turns on one key question: what kind of trust is it?

The Key Rule: Seller and Buyer Must Be the “Same Taxpayer”

A 1031 exchange requires the person who sells the old property and the person who buys the new one to be the same taxpayer for tax purposes. So the question becomes: is the trust a separate taxpayer?

Revocable Living Trusts: Yes, and Easily

The revocable living trust most people create is, for income tax purposes, a “grantor trust,” and the tax law treats it as the grantor: the trust does not file its own return, and its income is reported on the grantor’s personal return.

So:

• Selling in the trust’s name and buying in the trust’s name: fine;
• Selling in your own name and buying in the trust’s name (or the reverse): generally fine too, because for tax purposes it is the same person;
• Transferring the replacement property into your revocable trust after the exchange: usually no problem.

A practical note: title companies, intermediaries and lenders will need to see the trust or a trust certification to confirm the trustee’s authority to sign.

Irrevocable Trusts: It Depends on Grantor Trust Status

• Irrevocable trusts that are still grantor trusts (such as certain trusts designed for estate tax or asset protection planning) are still treated as the grantor for income tax purposes and can generally be handled the same way, but an attorney should review the trust terms to confirm;
• Non-grantor trusts (which file their own returns) are separate taxpayers. The same trust must both sell and buy. You cannot sell in the trust’s name and then buy in your own name or another trust’s name.

What If the Owner Dies During the Exchange?

If the owner dies during the 45-day or 180-day period, the executor or successor trustee can generally complete the exchange. If the property is already in a revocable trust, the successor trustee can step in immediately without waiting for court authority, which is one of the advantages of a trust.

Can I Give the Replacement Property to My Children’s Trust?

Be careful. A 1031 exchange requires the replacement property to be held for investment. If you give it to your children or transfer it to their irrevocable trust right after the exchange, the IRS may argue you never intended to hold it for investment. If you plan a gift, hold the property for a while first, and time it with your attorney and accountant.

Also, gifted property does not receive a step-up in basis at death, and the deferred tax passes to the recipient (see Part 10).

A Different “Trust”: Using a DST as Replacement Property

People asking whether a “trust can do a 1031” sometimes mean a Delaware Statutory Trust (DST). In Rev. Rul. 2004-86, the IRS recognized that qualifying beneficial interests in a DST can be treated as a direct interest in real property and used as replacement property in a 1031 exchange.

Features of a DST:

• Passive investment: professionals manage the property, and you are not a landlord;
• Eligibility and limits: usually offered only to accredited investors; investors have no management control, and the trust’s own operations are tightly restricted;
• Illiquid: typically held for years and hard to sell midway;
• Fees: review the offering documents carefully for fees and risks.

For aging landlords who no longer want to manage property but want to keep deferring tax, a DST is often used as the “last stop.”

Can a Co-op in a Trust Be Exchanged?

Putting a co-op in a trust requires board consent (see Part 9 of our “New York Trust Series”). As replacement property, you also need to confirm the building allows renting. When a trust, a 1031 exchange and a co-op are stacked together, a snag in any one can derail the exchange.

Attorney’s Insight

Trusts and 1031 exchanges don’t conflict. Designed well, they reinforce each other: the 1031 exchange defers tax and keeps the investment growing, and the trust ensures a smooth handoff during incapacity or after death without probate. Our advice:

• Pull out your trust documents before you sell. Confirm whether the trust is revocable or irrevocable, whether it is a grantor trust, who the trustee is and whether the trustee has power to buy and sell real estate;
• Decide in advance how the replacement will be titled. Buying directly in the name of your revocable trust does it in one step and saves a later deed transfer and its costs;
• Plan the 1031 exchange and your estate plan together. For landlords who intend to hold property for life, a “1031 plus trust” approach often balances tax and succession (see Part 10).

Attorney’s perspective

With trust-owned property, the key questions are the type of trust and the “same taxpayer” rule. Because we handle both wills and trusts and real estate closings, we can review the trust document and the title together.

For advice about your own situation, call +1 718-218-5805 or schedule a consultation. We meet clients in Flushing and Manhattan, in English or Chinese.

Series overview

This article is for general information only and is not legal advice. Reading it does not create an attorney-client relationship. For advice about your situation, please contact us.

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