How to Make Sure You Keep Your Options Open
Many commercial property owners have acquired real estate in partnership over the years. Some purchased buildings with business partners to house their operations, while others teamed up with investors to acquire income-producing properties for cash flow, appreciation, and diversification.
In either case, if you co-own commercial property, it’s critical to ensure that your ownership structure allows flexibility when it’s time to exit. Disposition decisions often trigger significant tax, legal, and estate consequences, especially when partners’ goals diverge.
In this post, we take a closer look at ownership structure and title vesting, and why preparing before you need to act can preserve valuable options later.
Why Exit Planning Is Often Overlooked
When investors combine resources to acquire commercial real estate, they typically perform extensive due diligence on the acquisition itself. Everyone agrees on what to buy, why to buy it, and how to structure the purchase.
What’s often neglected is the exit.
Because a sale may be decades away, planning for a future disposition tends to take a back seat to closing the deal. Unfortunately, that lack of planning can severely limit options when life events, market changes, or estate issues force a decision.
Why LLC Ownership Structures Are So Common
Most commercial properties are acquired through Limited Liability Companies (LLCs) formed specifically to hold title. This structure provides liability protection and clearly defines the rights and responsibilities of each member.
From a legal and operational standpoint, LLCs make excellent sense and are widely recommended by real estate attorneys, estate planners, and financial advisors.
If drafted properly, the operating agreement also addresses how and when the property may be sold, an issue that becomes especially important as ownership passes to heirs or partners’ priorities shift.
The 1031 Exchange Limitation Most Owners Miss
One of the most frequently overlooked challenges with LLC ownership arises during disposition: 1031 exchange limitations.
While an LLC can exchange the property as a whole into a replacement asset, individual members cannot exchange their separate ownership interests. This becomes problematic when some partners want to exchange and others want to cash out.
This issue often surfaces only after a sale is already in motion, when options are limited and consequences are expensive. This is a common problem for owners considering 1031 exchange strategies for commercial property held in LLCs.
The Drop & Swap Strategy Explained
There is a solution, but it requires time and intentional planning. It’s commonly referred to as a Drop & Swap.
In this approach:
- The title is transferred from the LLC to the individual members as Tenants in Common (TIC)
- The property is held in TIC form long enough to demonstrate legitimate ownership intent
- Members may then individually pursue separate 1031 exchanges upon sale
However, two important considerations apply:
- Liability protection provided by the LLC is removed
- The sale must typically be delayed by at least one tax year (some advisors recommend two)
While this may seem excessive, it reflects how the IRS interprets intent under current rules.
Why Planning Early Creates Real Optionality
Given these constraints, we often recommend that LLCs with multiple non-family members plan an eventual exit from the LLC structure well before disposition. Doing so creates flexibility for partners to pursue different outcomes when the time comes.
This may sound counterintuitive, after all, why form an LLC only to unwind it later?
The answer is simple: time changes everything.
Many owners have held properties for decades. Over that time, goals change, health changes, heirs become involved, and markets shift. Early planning allows owners to adapt without being forced into suboptimal outcomes. This is especially relevant for owners engaged in long-term industrial real estate planning.
What’s Next
Next week, we’ll walk through a hypothetical example showing what can go wrong when an LLC structure collides with an unanticipated disposition — and how early preparation could have avoided it.
Concerned Your Ownership Structure May Limit Your Options? Let’s Review It.
If you own commercial property with partners and haven’t evaluated how your ownership structure affects future sale or exchange options, now is the time. A proactive review can help you avoid unnecessary taxes, delays, and conflicts down the road.
👉 Speak with a Zehner Hill industrial real estate advisor