Disregarded Entities Held in High Regard

BY ALISTAIR M. NEVIUS

  

 
 

In the decade since the “check-the-box” (CTB) regulations took effect, tax and business planners have taken advantage of their flexibility to structure a wide variety of transactions. Perhaps the most beneficial tax and business planning tool encouraged by CTB regulations is the single-member limited liability company (SMLLC). This has led to the rise of the SMLLC as an entity of choice in the facilitation of like-kind exchanges.

FEDERAL TAX TREATMENT
Under the CTB regulations, by default, an SMLLC is treated as a “disregarded entity” (DE); see Treas. Reg. § 301.7701-3(b)(1). Under Treas. Reg. § 301.7701-2(a), the consequence of being classified as a DE is that the SMLLC is treated as if it does not exist separately from its owner for federal income tax purposes; the DE’s sole owner reports all the entity’s income, gain, loss, expense, etc. directly on the owner’s tax return.

SMLLCs AND LIKE-KIND EXCHANGES
SMLLCs have evolved into an important part of IRC § 1031 deferred-exchange transactions. Under section 1031(a)(3), once the taxpayer has disposed of the relinquished property, the taxpayer has 45 days to identify a replacement property and 180 days to acquire it. If the taxpayer receives property (including cash) in an exchange that is not of like kind, the section 1031 gain-deferral provisions do not apply, according to section 1031(b). Thus, “qualified intermediaries” (QIs) typically become involved, so the taxpayer does not directly receive nonqualified property from the buyer. The QI often creates an SMLLC to receive cash and/or properties held as part of the deferred like-kind exchange until the exchange is complete. The IRS has ruled that a like-kind exchange accommodator’s use of a DE as titleholder to exchange properties will not disqualify the transaction (see Treas. Reg. § 1.1031(k)-1(g)(4)(i); Rev. Proc. 2000-37; and IRS Letter Ruling 200118023). At the same time, the SMLLC provides the accommodator (the SMLLC’s sole owner) with liability protection under state law.

SMLLCs are also commonly used in “reverse” section 1031 deferred exchanges. In a reverse exchange, the taxpayer acquires the replacement property before disposing of the relinquished property. In short, the taxpayer “parks” the replacement property with a QI or “exchange accommodation titleholder” until the taxpayer can dispose of the relinquished property within the allowed period. The exchange accommodator will most likely set up a special-purpose entity (usually an SMLLC) to hold the parked property for the taxpayer until the exchange is complete. If done properly, the structure protects the exchange accommodator from the potential liabilities associated with the parked property. It also eliminates some significant tax and non-tax problems that an S corporation, a C corporation or a partnership would create if those were the only entities available to the exchange accommodator.

For a detailed discussion of the issues in this area, see “The Rising Popularity of SMLLCs in Tax and Business Planning,” by Ryan H. Pace, M.Tax., J.D., LL.M., in the August 2007 issue of The Tax Adviser.

—Alistair M. Nevius, editor-in-chief
The Tax Adviser

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