Spousal Vesting Issues and 1031 Exchanges

Generally it is recommended that no changes be made to the way title to property is held shortly before or after a 1031 Exchange.  For example, if title to an apartment building is held by Lisa and Russell as husband and wife, title to the new replacement property should be held in the same manner. However, sometimes a lender may require a change in title (“vesting”) as a condition to providing a loan for the replacement property, such as requiring the couple to own the new property in only the name of the husband or wife. An IRS statute which created unlimited gifting between spouses exists, which may help address situations like the above, this issue is not clearly resolved. This situation could be problematic for spouses who have entered into a 1031 Exchange since appeasing the lender may invalidate their 1031 Exchange.

 

The last time the IRS issued a memorandum related to spousal vesting was in 1984.  At that time spouses did not receive a favorable ruling. The IRS position was that each spouse is a separate taxpayer, therefore each owned a separate half of the jointly owned property (even if they file a joint return). In Technical Advice Memorandum (TAM8429004), the IRS ruled that where both spouses were on title to the relinquished property but only one spouse was on title to the replacement property, the other spouse was deemed to have gifted their portion of the proceeds, and must pay tax on 50% of the gain. Although this guidance from the IRS was issued in 1984, the underlying facts (and the applicable law) arose in 1983.

 

Later in 1984, Congress passed IRC section 1041.  This law, which remains in effect today, created unlimited tax free gifting between spouses.  Since this issue has not been revisited since the enactment of Section 1041, it is not clear if the IRS would still issue the same ruling today as it did in TAM8429004. Since it is unresolved, many tax advisors suggest the following with respect to the spousal title scenarios below:

 

  • Example A: One spouse is on title to the relinquished property  but the lender wants both on the title to the replacement property:
    • Have counsel prepare an agreement that the co-signing spouse is doing so in trust for the other spouse; the replacement property is the separate property of other spouse and that no gift has occurred.
  • Example B: If there is no lender requirement – only the spouse on title to the relinquished property should be on title to the replacement property:
    • The property can be placed in a revocable living trust with the other spouse named as the beneficiary to protect from an untimely death until they can safely be added to title.
  • Example C: If both spouses are on title to the  relinquished property and lender only wants only one on the replacement property there is not a clear answer:
    • The spouses may need to find a new lender or rely on the unlimited gifting provision of section 1041.

 

Taxpayers should always consult with a competent tax advisor for advice with respect to their individual situation.

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