Can an LLC Do a 1031 Exchange? What Real Estate Investors Should Know

Key Takeaways

LLCs can complete 1031 exchanges, but rules differ depending on whether they are single-member or multi-member.
The IRS enforces the same taxpayer rule: The entity or individual who sells must also reinvest.
Single-member LLCs are disregarded entities, so the owner is treated as the taxpayer for the exchange.
Multi-member LLCs can exchange as an entity, but issues arise when members disagree on reinvestment.
Strategies like “drop and swap” can be used, though they require careful planning, and IRS scrutiny is common.
Delaware Statutory Trusts (DSTs) allow LLCs to access institutional-quality properties while enjoying passive ownership.

Many investors hold real estate through a limited liability company (LLC). When it’s time to sell, the natural question is: Can an LLC complete a 1031 exchange to defer capital gains taxes?

Yes, but the way an exchange is structured, and whether all members agree on reinvestment, will determine how smoothly the process goes. Below, we’ll cover IRS rules, the differences between single-member and multi-member LLCs, strategies for handling disagreements, and how DSTs can provide a streamlined solution.

What Does the IRS Say About LLCs and 1031 Exchanges?

The IRS does not prohibit LLCs from completing 1031 exchanges. In fact, entities of all types (LLCs, corporations, and trusts) regularly use this tool to defer capital gains taxes. The most important compliance factor is the same taxpayer rule:

The taxpayer who sells the relinquished property must be the same taxpayer who purchases the replacement property.

This rule plays out differently depending on whether the LLC is single-member or multi-member.

It’s also important that the property sold (and the property acquired) be held for investment or business purposes, not personal use.

Can a Single-Member LLC Do a 1031 Exchange?

Yes, single-member LLCs are considered disregarded entities for federal tax purposes. That means the IRS ignores the LLC structure and treats the individual owner as the taxpayer. For example:

If John Smith owns a commercial warehouse through a single-member LLC, the IRS sees John Smith, not the LLC, as the seller.
When John performs a 1031 exchange, he is also treated as the buyer of the replacement property.
As long as deadlines and reinvestment requirements are met, the exchange qualifies.

Additional Considerations for Single-Member LLCs

Multiple SMLLCs: Regardless of how many SMLLCs an individual owns, the IRS still sees the individual as the taxpayer. Exchanges can be structured across different disregarded entities as long as the underlying taxpayer remains the same.
Electing corporate treatment: If a single-member LLC elects to be taxed as a corporation, it becomes its own taxpayer. At that point, the LLC—not the individual—must complete the exchange.
Recordkeeping: Even though the IRS disregards the LLC for tax purposes, investors should still keep clear records through the LLC entity for liability and organizational purposes.

Can a Multi-Member LLC Do a 1031 Exchange?

Yes, but the process is more complex. Most multi-member LLCs are taxed as partnerships, meaning the LLC itself—not the members—is the taxpayer.

Key Implications

The LLC must complete the exchange.
If the LLC sells a property and reinvests all proceeds into new property, the exchange can fully defer taxes.
Individual members cannot peel off their portion during the exchange without triggering taxable events.

The Challenge of Diverging Member Goals

Issues occur when not all members agree to reinvest.

For example:

A three-member LLC sells a $6 million apartment complex. Two members want to reinvest through a 1031 exchange, but one wants cash.

If the LLC distributes proceeds to the member who wants out, the IRS may treat that distribution as boot, cash outside the exchange, leading to a taxable gain.

Because the LLC is the taxpayer, the entity’s compliance requirements take precedence over individual member goals. Early planning is essential for partnerships.

What If LLC Members Disagree on Reinvestment?

When LLC members disagree on reinvestment, two options exist: sell the property at the entity level — applying a single tax outcome to all members — or distribute the property to members before the sale so each can decide independently. The latter approach is known as a drop and swap.

When an LLC sells property at the entity level, all members share the same tax outcome. One member cannot defer while another cashes out. Because each member holds an interest in the entity, not the underlying real estate, partnership interests do not qualify for a 1031 exchange under Section 1031 of the Internal Revenue Code.

A drop and swap 1031 exchange separates those decisions:

Drop: The LLC distributes ownership of the property to members before selling. Each becomes a tenant-in-common (TIC).
Decide: Each member independently chooses to defer gains through a 1031 exchange or cash out.
Swap: Exchanging members engage their own qualified intermediary and pursue replacement property individually.

Risks of drop and swap:

Timing: If the drop occurs immediately before the sale, the IRS may argue the property wasn’t “held for investment,” disqualifying the exchange.
Scrutiny: Courts have challenged drop-and-swap arrangements when they look like last-minute maneuvers.
Planning window: The structure is most defensible when the planning precedes the sale rather than reacting to it.

Members considering this route should engage a CPA and a tax attorney before a buyer is under contract.

Other Strategies for Multi-Member LLCs

In addition to drop and swap, investors sometimes use:

Cash-Out Refinance: After reinvestment, the LLC refinances the new property and distributes loan proceeds to members who want liquidity.
DST Investments: The LLC exchanges into a Delaware Statutory Trust, which issues fractional interests that can be more easily divided among members.

Each path carries unique compliance and timing considerations.

Common Scenarios for LLC Exchanges

Husband-and-Wife LLC

A couple owns a small multifamily property through an LLC. They perform a 1031 exchange into a DST for passive ownership, preserving income without daily landlord duties.

Family Partnership

Parents and children co-own a retail property. The children want cash for new ventures, while the parents want to continue with tax deferral. A drop and swap or DST allocation may accommodate both outcomes.

Investor Group LLC

A group of physicians owns a medical office building. As they near retirement, they perform a 1031 exchange and reinvest the sale proceeds into a professionally managed DST. In doing so, day-to-day management responsibilities are eliminated while maintaining potential cash flow.

These examples show how different LLC structures require tailored approaches.

Key Requirements for LLCs Doing 1031 Exchanges

LLCs must follow the same IRS rules as individual investors performing a 1031 exchange:

Like-kind property: Both the relinquished and replacement properties must be real estate held for business or investment use (not personal). For more details on what qualifies, see Investopedia’s definition of like-kind property.
45/180-day deadlines: identify your replacement property within 45 days and close by the earlier of 180 days or your tax return due date (with extensions).
Qualified Intermediary (QI): Sale proceeds must be held by a QI—not the LLC or its members.
Equal or greater reinvestment: To fully defer taxes, reinvest all proceeds into a replacement property that is of equal or greater value than the relinquished property
Same taxpayer rule: The entity that sells must also acquire the replacement property.

Failure to meet any of these requirements may trigger immediate taxation.

Can an LLC Invest in a DST for a 1031 Exchange?

Yes, LLCs, like individuals, can utilize a Delaware Statutory Trust (DST) as replacement property for the purposes of a 1031 exchange. DSTs may be suitable for partnerships as this vehicle offers passive ownership and fractional interests.

Why DSTs Work for LLCs

Passive ownership: DSTs are managed by professional sponsors, so LLC members don’t have to handle the day-to-day operations of the property. This structure may be attractive to members who no longer want the burden of active management.
Diversification: Many DSTs hold portfolios of multifamily, medical office, senior housing, or NNN-leased properties. This variety allows LLC members to spread risk across multiple property types instead of being tied to a single asset.
Ease of division: DST interests can be allocated proportionally among LLC members. This makes it easier to divide ownership fairly and avoid disputes over who controls or benefits from the property.
Institutional access: DSTs often invest in large, institutional-grade real estate that smaller investors or LLCs couldn’t acquire on their own. By pooling funds, members gain access to higher-quality opportunities with professional oversight.

For LLCs with diverging goals or management fatigue, DSTs can offer a clear, compliant path forward. On the other hand, DSTs come with risks that LLCs should carefully evaluate, including:

Illiquidity: DST interests are generally long-term and not easily sold. LLC members should be prepared to hold their investment through the full lifecycle of the offering.
Loss of control: Investors have no decision-making authority over property operations, financing, or disposition. This makes sponsor selection and upfront due diligence especially important for LLCs.
Market and interest rate risk: Property performance may be affected by changes in market conditions, interest rates, tenant demand, or broader economic factors, which can impact cash flow and exit timing.
Sponsor and execution risk: DST outcomes depend heavily on the sponsor’s experience and ability to execute the business plan. Poor management or unfavorable market timing can affect returns.
Financing risk: Many DSTs use leverage, and loan terms—including maturity dates and interest rate structures—can influence cash flow and overall investment performance.

Practical Planning Tips for LLCs

Plan early: Waiting until after a sale contract is signed limits the options for a compliant exchange. Early planning preserves flexibility and mitigates the risk of rushed or failed strategies.
Align member goals: Members should agree in advance on whether to reinvest or cash out. Addressing these goals early prevents conflict and helps select the right tax-advantaged path.
Engage professionals: CPAs, attorneys, and QIs are essential for ensuring compliance. Their guidance can help avoid costly mistakes and keep the exchange on track.
Leverage DSTs: DSTs can be an effective tool when members want different outcomes, such as passive income versus liquidity. They offer a neutral way to reinvest proceeds while resolving disputes.
Avoid last-minute maneuvers: Strategies like “drop-and-swap” can work, but if done hastily, they carry high audit risk. Careful planning and documentation are critical to avoid invalidating the exchange.
Document intent: Keeping clear records of how properties are held and why reinvestments are made strengthens compliance with IRS requirements. Strong documentation also reduces disputes among members down the line.

Mistakes LLCs Should Avoid

Distributing cash before reinvestment: If you take cash out of the sale proceeds before reinvesting, the IRS treats it as boot, which is taxable. For full tax deferral, investors need to reinvest all sale proceeds into the replacement property.

Mixing personal and business use: Only property held for investment or business purposes qualifies for a 1031 exchange. Personal-use property, like a primary residence or vacation home, generally does not.

Overlooking state-level rules: Some states require extra filings or withholdings even if the exchange is valid federally. Missing these rules can lead to unexpected taxes or penalties.

Ignoring timeline pressure: Investors have 45 days to identify and 180 days to close on a replacement property. Missing either deadline means the entire exchange fails and gains become taxable.

Not considering long-term exit strategies: A 1031 exchange defers taxes but doesn’t eliminate them. Planning ahead—such as evaluating future investment options or integrating estate planning—helps ensure flexibility and alignment with long-term goals.

LLCs Can Defer Taxes With the Right Planning

LLCs can absolutely complete 1031 exchanges, but the rules differ depending on structure and member alignment. Single-member LLCs are the most straightforward, while multi-member LLCs require careful planning, especially when members want different outcomes.

For those seeking passive ownership, reduced management responsibilities, and access to institutional-quality opportunities, DSTs offer a compelling solution.

With the right structure and guidance, LLC investors can defer capital gains taxes, preserve equity, and transition into professionally managed real estate—all while remaining IRS-compliant.

Want to learn how your LLC can use a 1031 exchange to defer taxes? Register for a free investor account today to view properties in our exclusive marketplace and explore DST opportunities designed for accredited investors.

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