Real Estate 1031 Exchange Question for S-Corp Selling Business Assets - Possible to Purchase Rental Property?

This is a tricky situation with several important tax considerations. Let me break this down: For a 1031 exchange, the property being sold and the property being acquired must both be held for productive use in a business or for investment. The challenge here is that they're selling business assets but want to buy property for leasing (investment). These are different uses which could disqualify them from 1031 treatment. The timing issue creates another problem. In a 1031 exchange, you must identify potential replacement properties within 45 days of selling and complete the purchase within 180 days. They can't do a 1031 exchange for a property purchased before selling the original property. As for creating an LLC to buy the property now and having the S-Corp purchase it later - this would likely not qualify for 1031 exchange treatment. The IRS would view this as two separate transactions: 1) the LLC buying property and 2) the S-Corp buying from the LLC, rather than a direct exchange.

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Some important nuances your relatives should consider regarding the S-Corp situation: 1. If they keep the S-Corp but change the main business activity from operating a business to holding rental property, they need to be careful about the "passive investment income" rules. S-Corps that previously operated active businesses but switch to primarily generating passive income (like rent) can face additional taxes if they have accumulated earnings and profits from C corporation years. 2. They should also consider whether keeping the S-Corp structure makes sense for rental property. There are often better entities for holding rental real estate, like an LLC taxed as a partnership or even direct ownership, depending on liability concerns and their specific situation. 3. The "step transaction doctrine" would likely apply if they create an LLC, buy property, then have the S-Corp buy it right after the asset sale. The IRS might treat it as a single transaction and disallow 1031 treatment.

Just to clear up some confusion about 1031 exchanges specifically - there are two key points that would make this challenging: 1. The "held for investment" requirement: The property being sold must be held for investment purposes or used in a trade or business. While their business property likely qualifies, changing the use from business operations to rental income might be problematic. The IRS looks at intent, and they might question whether the original property was truly "held for investment." 2. Timing issues: A 1031 exchange requires you to first sell your property, then acquire the replacement property within specific timeframes. You can't acquire the replacement property first (which is what the LLC scenario would be attempting to do). The reverse 1031 exchange does exist, which allows buying the new property before selling the old one, but it's complex and requires a specialized Exchange Accommodation Titleholder to temporarily hold title to one of the properties.