# When Co-Owners Want Out: Splitting Trust Property Through 1031 Exchanges
A woman called our office recently. She lives in Arizona. She and her ex-husband are co-trustees and beneficiaries of a revocable living trust that holds title to three rental houses in Lacey, Washington — Thurston County, just south of Olympia. Each of them has a 50% interest in each property. They want to go their separate ways.
Before she called us, she spoke with another qualified intermediary. A young woman at the firm told her she didn't know what she was talking about.
She did know what she was talking about. She even used the term "swap and drop" — which showed she had done her research. The structure she described was entirely workable. It just required a QI who understood trust ownership, simultaneous exchanges, and the interplay between legal conveyancing and exchange facilitation.
This article explains the structure — what it is, why it works, and why the distinction between a "swap and drop," a "drop and swap," and a revocable trust conveyance matters.
The Situation
Three rental houses, all in Lacey, WA. All titled in a revocable living trust. Two co-trustees, each a 50% beneficiary. No debt on any of the properties — no lender approvals needed.
The goal:
Properties 1 and 2: Each co-owner takes 100% of one property. She gets her chosen house; he gets his. A straight swap of their respective 50% interests.
Property 3: She relinquishes her 50% interest to him. The proceeds from that relinquishment go to a qualified intermediary, and she uses them to acquire a replacement property in Arizona through a deferred 1031 exchange.
Three properties, two people, two different exchange structures — simultaneous and deferred — all arising from the same trust.
Why a Revocable Living Trust Simplifies This
Here is where the other QI's employee got confused. She likely heard "trust" and assumed the structure was complicated. In fact, a revocable living trust is the simplest entity to deal with in a 1031 exchange — because for federal tax purposes, it doesn't exist as a separate taxpayer.
A revocable living trust is a grantor trust under IRC §§671–679. The IRS treats each grantor-beneficiary as the owner of their share of the trust assets. The trust does not file its own income tax return. Each beneficiary reports their share of income and gain on their individual Form 1040.
This means the trust is a disregarded entity for 1031 purposes. When Property 1 is conveyed from the trust to the wife, that is not a taxable event — it is a distribution from a grantor to herself. The tax identity hasn't changed. She owned 50% before the conveyance (through the trust), and she owns 50% after the conveyance (directly). The basis carries over. No gain is recognized.
This is the critical distinction between this structure and a "drop and swap" involving a partnership or multi-member LLC. In those entities, distributing property to the partners before an exchange requires careful analysis under §§704(c)(1)(B) and 737 to avoid triggering gain. Those rules don't apply to revocable trusts because there is no entity-level taxation to navigate.
The Two Exchange Structures
Properties 1 and 2: Simultaneous Exchange
The swap of 50% interests — she gives him her half of Property 1, he gives her his half of Property 2 — is a simultaneous exchange under Section 1031. Both parties are exchanging like-kind real property held for investment. The fact that the properties are located in the same city and are similar in character doesn't matter — all real property is like kind to all other real property under the post-TCJA framework.
The mechanics:
- Convey both properties out of the trust into the respective co-owners' names as tenants in common (or as the trust directs).
- Execute the simultaneous exchange — she deeds her 50% of Property 1 to him, he deeds his 50% of Property 2 to her.
- Assign existing leases to the new sole owners.
If the values are equal, there is no boot. If they are not equal, the party receiving the higher-value property may need to pay the difference, and the party receiving cash recognizes gain to the extent of the boot received.
A simultaneous exchange does not require a qualified intermediary. But proper documentation is still essential — the exchange agreement, the deeds, and the assignment of lease rights should all reflect the exchange intent. If a QI is involved (which I recommend), the transaction is cleaner and the documentation is bulletproof.
Property 3: Deferred Exchange
Her 50% interest in Property 3 is relinquished to him. The proceeds go to a qualified intermediary. She then has 45 days to identify replacement property and 180 days to close on it.
She plans to acquire a replacement property in Arizona. Interstate exchanges are routine — Section 1031 has no geographic limitation. Washington property can be exchanged into Arizona property, Texas property, or property in any other state. The only requirements are that both the relinquished and replacement properties be real property held for investment or use in a trade or business.
The deferred exchange requires a QI. The exchange funds cannot touch the exchanger's hands or bank account at any point during the exchange period. The QI holds the proceeds from the sale of the relinquished property interest and disburses them at the closing of the replacement property.
"Swap and Drop" vs. "Drop and Swap" — And Why Neither Label Fits Perfectly Here
The client used the term "swap and drop." She was close, but the structure is actually closer to a "drop and swap" — except better, because the trust is a disregarded entity.
Here's the terminology:
Drop and swap: The entity (typically a partnership or LLC) distributes ("drops") property to its members, who then exchange individually. The risk: the distribution may trigger gain under the partnership tax rules if not properly structured and timed.
Swap and drop: The entity does the exchange first ("swaps"), acquires replacement property, and then distributes ("drops") the replacement property to its members. The risk: if the distribution occurs too soon after the exchange, the IRS may argue the replacement property was not held for investment — it was held for distribution.
This structure: The trust conveys property to the individual beneficiaries, who then exchange. Because the trust is a revocable grantor trust — a disregarded entity — the conveyance out is not a taxable event at all. There is no partnership distribution to analyze, no §704(c)(1)(B) lookback period, no §737 mixing-bowl transaction. The beneficiaries step into the same tax position they already held, and the exchange proceeds from there.
This is one of the advantages of holding investment property in a revocable living trust rather than a partnership or LLC. When it's time to separate co-owned interests, the exit is cleaner.
The Legal Work and the Exchange Work — In One Engagement
In most scenarios like this, the property owners would need to hire a real estate attorney to prepare the deeds, handle the conveyances out of the trust, assign the leases, and ensure the title work is correct — and then separately hire a qualified intermediary to facilitate the exchanges.
This raises a natural question: if an attorney has a professional relationship with the client, doesn't that make the attorney a "disqualified person" who cannot serve as QI?
The answer is no — provided the legal services relate to the exchange.
Treasury Regulation §1.1031(k)-1(k)(2) defines a "disqualified person" as anyone who has acted as the taxpayer's employee, attorney, accountant, investment banker or broker, or real estate agent or broker within the two-year period ending on the date of transfer of the relinquished property. A disqualified person cannot serve as a qualified intermediary.
But the regulation includes a critical safe harbor. When determining whether a person is disqualified, the following services are not taken into account:
Services for the taxpayer with respect to exchanges of property intended to qualify for nonrecognition of gain or loss under section 1031.
This means an attorney who provides legal services solely in connection with the exchange — preparing conveyancing documents, recording deeds, assigning leases, structuring the transaction — is not disqualified from serving as the qualified intermediary for that same exchange. The regulatory drafters recognized that the legal work and the exchange facilitation work are inherently connected, and that requiring taxpayers to hire separate professionals for each function would create unnecessary cost and coordination risk.
At Olympic Exchange Accommodators, both functions are handled by the same person. As an attorney and a Certified Exchange Specialist, I prepare the conveyancing documents, record the deeds, assign the leases, structure the simultaneous exchange, and serve as QI for the deferred exchange. The legal work is performed within the context of enabling the exchange — exactly the scenario contemplated by the safe harbor regulation.
This matters because the legal and exchange components are interdependent. The order of operations — conveyance out of trust, then exchange — must be correct. The deeds must reflect the right parties and the right interests. The exchange documentation must reference the correct legal descriptions. Having one professional who understands both the legal structure and the exchange mechanics eliminates the coordination risk that arises when these functions are split between two firms.
Key Considerations for Similar Situations
If you are a co-owner of investment property held in a trust, an LLC, or as tenants in common, and you want to go your separate ways, here are the questions to work through:
What type of entity holds title? A revocable trust, an irrevocable trust, a partnership, an LLC, or a tenancy in common? The answer determines whether the distribution step creates a taxable event.
Is there debt on the properties? Debt complicates both the conveyance and the exchange. Mortgage relief is treated as boot under §1031, and lender consent may be required to transfer title.
Are the values equal? Unequal values create boot, which triggers partial gain recognition. An appraisal or CMA should be obtained before structuring the exchange.
Where will the replacement property be located? Section 1031 has no geographic restrictions, but state tax consequences vary. Arizona, for example, conforms to federal 1031 treatment — so the deferred gain will not be taxed at the state level upon the exchange. (Not all states conform.)
Can your QI handle the legal work? Most cannot. Most qualified intermediaries are not attorneys. If the transaction requires deed preparation, lease assignments, or entity restructuring, you will need separate legal counsel — unless your QI is also an attorney.
The Bigger Point
The woman who called us knew what she needed. She had done the research. She used the right terminology. And she was told by another facilitator that she didn't know what she was talking about.
She did. The facilitator's employee didn't.
This is why choosing a qualified intermediary matters — not just for the exchange facilitation, but for the ability to understand complex ownership structures and provide a complete solution. A QI who only processes standard forward exchanges will not recognize a workable structure when it walks through the door.
Olympic Exchange Accommodators is an attorney-led qualified intermediary based in Tacoma, serving property owners throughout Washington State — including Thurston County, Olympia, Lacey, and Tumwater — and nationwide. We facilitate forward, reverse, improvement, and simultaneous tax-deferred like-kind exchanges. There is no consultation fee to discuss your situation.
Jeff Helsdon is a Certified Exchange Specialist® who has been facilitating tax-deferred like-kind exchanges since 1990. He is the principal of Olympic Exchange Accommodators in Tacoma, Washington, and practices law at The Helsdon Law Firm, serving investors throughout Pierce County, Thurston County, the Puget Sound region, and Washington State.
Disclaimer: This article is for informational purposes only and does not constitute legal, tax, or financial advice. Every exchange has unique facts and circumstances — particularly transactions involving co-owned property, trust structures, and multi-state exchanges. Consult your own attorney, CPA, and financial advisor before making decisions about your 1031 exchange.
