"THE RULE"

While there is not a requirement specifically stated in IRC Sec. 1031 or the accompanying Regulations, a basic rule for Exchangers is that there must be continuity of title in the qualifying properties and this is particularly significant with regard to real property and personal property whose ownership evidenced by a certificate of title. This is commonly referred to in the 1031 Exchange industry as the "same taxpayer rule". It means that title to the Replacement Property in an Exchange must be ultimately acquired in the same name of the same party (as reflected on the tax return) as the party or entity holding title to the Relinquished Property. As with any rule there are always exceptions.

EXCEPTION TO RULE - DISREGARDED ENTITIES

A significant exception to the general rule described above arises when the transferor of the Relinquished Property or the transferee of the Replacement Property is a "disregarded entity" or the "owner" of a disregarded entity. A disregarded entity is an entity that holds legal title to property but is not required to file an income tax return. The entity is treated by the IRS as if it does not exist and the owner and the entity are, in effect, one and the same.

There are four basic disregarded entities:  The four types of disregarded entities are: the Trustee of a Revocable Living Trusts; Illinois-type Land Trusts; Single Member Limited Liability Companies and Delaware Statutory Trusts.  We have discussed Trusts previously and will direct our attention in this article to Limited Liability Companies.

LIMITED LIABILITY COMPANIES (LLCs)

Use of disregarded entities provides flexibility in exchange planning.  For example, an individual who sells a Relinquished Property in his or her individual name may acquire the Replacement Property in a single member limited liability company.  This provides additional liability protection for the Taxpayer.  

Limited liability companies ("LLC") a creatures of state statutory law and may be considered as a disregarded entity in the following cases where the LLC has not made an election to be treated for tax purposes as a corporation. Where:

100% of the member interests are owned by a single legal entity or a natural person.

100% of the interests are owned by husband and wife as community property in a community property state.

The IRS has explicitly approved treating a single member LLC as indistinguishable from its only member. Pursuant to Revenue Procedure 2002-69 applicable in the community property states (Arizona, California, Idaho, Louisiana, Nevada, New Mexico, Texas, Washington and Wisconsin), an LLC owned solely by a husband and wife as community property can be considered a disregarded entity for federal tax purposes even though the LLC technically has two members, However, states such as North Carolina that are not community property jurisdictions do not fall under this Revenue ruling and the IRS has explicitly refrained from applying disregarded treatment to a married couple holding as tenancy by the entirety to their jointly owning a two member LLC for the purpose of utilizing Internal Revenue Code Section 1031 treatment. The LLC's in question are treated as what they are...two member entities.

DELAWARE LLC EXCEPTION

As an exception of limited application, it should be noted that the IRS has ruled that a two-member LLC formed under Delaware law was disregarded for Internal Revenue Code Section 1031 exchange purposes where all economic interests were held by one member and the function of the second member was solely to prevent a bankruptcy filing or other violation of the LLC's covenants with lenders.  The IRS has also ruled that the acquisition of all the ownership interests held by 2 different owners by a single buyer in a single transaction constituted an acquisition of the underlying assets owned by the LLC.

If you have any questions concerning the use of disregarded entities for Internal Revenue Code Section 1031 Exchange planning, please be sure to contact our helpful and experienced staff at STEC, The 1031 Professionals ™

High Point Bank & Trust Co. v Highmark Props., LLC

On discretionary review of a unanimous decision of the Court of Appeals, ___ N.C. App. ___, 750 S.E.2d 886 (2013), finding no error in orders of the respective trial courts, the Supreme Court allowed defendants' conditional petition for discretionary review as to additional issues. The issue of a guarantor's liability for a foreclosure deficiency was raised again on appeal in less than a year from the prior reported case. In Court of Appeals opinions cited in the Court of Appeals opinion, the Court has made a distinction of finding availability of the defense where the mortgagor was a party to the action, but determining that it was unavailable when not a party.

The borrower was voluntarily dismissed by the plaintiff in this deficiency action and the trial court ordered an offset after the borrower was re-joined in the action pursuant to N.C.G.S. § 26-12(b). The jury found that the value of the property at the time of the foreclosure sale represented the bulk of the debt though the lender's bid was substantially lees. The plaintiff argued that the defense and offset provided for in N.C.G.S. § 45-21.36 is personal to the borrower, and is not available to the guarantors simply because the borrower had availed itself of the offset defense.

While the Court of Appeals agreed that the plain language of N.C.G.S. Section 26-12(b) does not expand the defenses available to the guarantors beyond those that were available when the action was brought against both simply because of the re-joinder of the borrower, it held that the guarantors "were not allowed an offset defense, Borrower was. The fact that Guarantors "benefitted," because the amount of Borrower's indebtedness was determined at trial to be less than what Plaintiff claimed, does not alter this fact."

The Court parsed the issue in the case as "not whether a guarantor can personally assert an offset defense pursuant to N.C.G.S. § 45–21.36. We have not held that Guarantors had the right to avail themselves of the offset defense in N.C.G.S. § 45-21.36. We quite assiduously avoided making that determination. We hold that Guarantors were only responsible for Borrower's indebtedness. This holding is in accord with precedent and the language of the guaranty agreements drafted by Plaintiff. Once the jury and the trial court determined Borrower's indebtedness to Plaintiff, Guarantors' liability to Plaintiff was thereby established."

The distinction might seem a bit dubious in light of the opinions citation of Wells Fargo Bank, N.A. v. Arlington Hills of Mint Hill, LLC, N.C. App. __, __, 742 S.E.2d 201, 204 (2013) which held that the offset defense was personal to the borrower even though the borrower had been joined in the action against the guarantor. The majority determined that once Highmark was joined as a party, guarantors were entitled to benefit from Highmark's use of N.C.G.S. Section  45-21.36. However, the concurring judge reached the same result as the majority by concluding that guarantors could assert the anti-deficiency defense provided by N.C.G.S. Section 45-21.36 even if Highmark was not a party citing the North Carolina Supreme Court Virginia Trust Co. v. Dunlop, 214 N.C. 196, (1938) as ruling that the guarantor of a purchase money deed of trust is entitled to plead the anti-deficiency statute as a defense in an action brought on his personal guaranty. The concurring opinion points out that as the issue before the Supreme Court was the appropriateness of a motion to strike, the right to plead could only entail a right to prevail on the pleading. Also at issue was the appropriateness of the trial judge's joinder of the borrower, Highmark as a defendant in this action pursuant to N.C.G.S. Section 26-12 and the issue of whether the waiver of defenses in the Guaranty Agreement precluded the guarantors from raising the anti-deficiency defense of the statute.

As the controlling law supports the contention that the offset defense is not personal to the borrower, this Court of Appeals opinion set up the likelihood that the Supreme Court might resolve the question expressly rather than implicitly and that proved to be the case here.

After reciting the essential facts of the appeal, the Supreme Court observed that had previously addressed the essence of these arguments. It stated that it had held that guarantors are within the group of those protected by N.C.G.S. Section 45-21.36 citing Wachovia Realty Invs. v. Housing, Inc., 292 N.C. 93, (1977) "‘The statute provides only that when the creditor has elected to become the purchaser of the property conveyed by the mortgage or deed of trust at a sale made under a power of sale . . . he shall not recover judgment against his debtor for any deficiency, after the application of the amount of his bid as a payment on the debt, without first accounting to his debtor for the fair value of the property at the time and place of the sale, and that such value shall be determined by the court.' (quoting Richmond Mortg. & Loan Corp. v. Wachovia Bank & Tr. Co.(Richmond Mortgage), 210 N.C. 29, 185 S.E. 482 (1936), aff'd, 300 U.S. 124, 57 S. Ct. 338, 81 L. Ed. 552 (1937)). The effect is that the section establishes an equitable method of calculating the indebtedness; therefore, it is not a "defense" in the usual sense which can be waived."

Citing Virginia Trust Co. v. Dunlop, 214 N.C. 196, 198 S.E. 645 (1938), the Supreme Court stated that it had addressed an anti-deficiency statute containing language nearly identical to the present-day section N.C.G.S. Section 45-21.36 and concluding that a guarantor had the right to utilize the statutory protection at trial. The Court determined that its holdings in Dunlop and Richmond Mortgage are controlling, that a guarantor may raise the statutory defense, is entitled to its benefits when it has been determined that the property's fair value exceeded the purchase price paid by the creditor at the foreclosure sale, had the right to have the court determine the outstanding indebtedness by application of the fair market value of the collateral at the time of sale and that as the guarantors only guaranteed the repayment of the indebtedness which is merely being calculated pursuant to the statute, it is not the type of "defense or offset" which is subject to waiver.

It appears that the Court may have been concerned about the likelihood of creditor attempts to circumvent the doctrine confirmed in this case by the use of artful drafting of waiver language in future guaranty agreements. Such efforts are forestalled where, after a thorough analysis of the history and purpose of the statute the Supreme Court states; "we further conclude that because anti-deficiency legislation is so narrowly tailored to address specific instances of the public's vulnerability to lender overreach, waiver of this statutory protection as a prerequisite to receipt of a mortgage or as a condition of a guaranty agreement would violate public policy..."