Discussion:1031 within a partnership

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Discussion Forum Index --> Advanced Tax Questions --> 1031 within a partnership

Discussion Forum Index --> Tax Questions --> 1031 within a partnership

Rickh8 (talk|edits) said:

18 December 2009

Hi All,

I have a client who's in a partnership with four other partners (five total) and the own one apartment building. Based on my research it looks like you can do a 1031 exchange, however it appears not all the partners want to do an exchange, they are talking about selling the property and dividing the proceeds five ways evenly. My question is, can my client take his portion and do a 1031 exchange??? Any help would be appreciated! Thank you!

CrowCPA (talk|edits) said:

18 December 2009
I believe you need to first disolve the partnership so that the former partners become tenants in common. Then your client can use 1031 for his TIC interest.

I have never done this, but have a client who may eventually face the same situation. The TIC interest idea came up at a seminar on real estate issues. Allstates1031.com has a good website and I have referred clients to them with complex 1031 questions and for their services as a qualified intermediary.

LH2004 (talk|edits) said:

December 18, 2009
You could have the partnership do a 1031 exchange, buying out the partners that don't want a part of it (or the remaining partners could buy them out, or something); or, you could distribute the entire interest in the property, and then the separate partners could separately sell or exchange their interests. Selling the property for cash, distributing the cash and then having some partners buy replacements doesn't work.

DaveFogel (talk|edits) said:

18 December 2009
What you're talking about doing has been commonly referred to as a "partnership drop-down" where the partnership distributes an undivided interest in the property to each partner, then all partners transfer their interests to an intermediary. The intermediary sells the property to a third party, and some partners receive cash while others work with the intermediary to complete an IRC §1031 exchange for their relinquished undivided interests. This structure relies upon the cases of Magneson v. Commissioner, 753 F.2d 1490 (9th Cir. 1985) and Bolker v. Commissioner, 760 F.2d 1039 (9th Cir. 1985) for the tax-deferred §1031 exchange treatment. See also Mason v. Commissioner, T.C. Memo. 1988-273, involving a "partnership drop-down."

MWPXYZ (talk|edits) said:

20 December 2009
In spite of the court cases cited by Dave, the IRS has a history of attacking "drop and swap" exchanges. The intermediaries I have dealt with have declined to become involved in exchanges involving property that has dropped out of an LLC or partnership. It seems the sticking point is that these cases involve exchanges before 1984. In 1984 the exchange of partnership interests were no longer allowed under Section 1031. Thus, the intermediaries (and the IRS, I guess) believed these cases were no longer relevant.

In my opinion, I believe the logic of the judges would also apply in post 1984 transactions; but I don't seem to have much company.

I see from notes I have, there was a TA discussion started Sept 17 2007 involving RT and FTF65 on this issue that seemed to indicate section 704(c)(2) may "work".

DaveFogel (talk|edits) said:

20 December 2009
MWPXYZ, I don't believe that the intermediaries you have dealt with represent the majority. I have seen dozens of articles on the Internet and elsewhere written by 1031 exchange companies that claim the "drop and swap" or "partnership drop-down" exchange is still viable, providing that it is structured properly.

As you indicate, the problem is that an exchange of partnership interests doesn't qualify as a like-kind exchange under IRC §1031. However, in order to provide guidance in this area, the IRS announced, in Rev. Proc. 2002-22, 2001 C.B. 733, that it will consider issuing advance rulings as to when an undivided interest in rental real property is not an interest in a partnership. And pursuant to this Rev. Proc., the IRS has issued several private letter rulings holding that an undivided interest in property was not an interest in a partnership for purposes of IRC §1031(a). See PLRs 200327003, 200513010, 200625009, 200625010, 200826005, 200829012, and 200829013.

MWPXYZ (talk|edits) said:

21 December 2009
I would like to believe that "drop and swap" would work, and I thank you for the list of PLR's.

One sticking point that has been thrown back at me in discussions with intermediaries is that the drop of partnership assets to the partners creates the situation in which the partners have not held the property as either an investment or a "trade or business" asset. So the property is not eligible for Section 1031. I have read that the held-for-investment requirement is interpreted by the IRS as meaning that you have to hold the property for at least one year and one day. You cannot add the time you owned the property through the partnership to the time you own the property individually. Now there is nothing in the Tax Code or the regulations on the time period you must hold the property. The IRS did want Congress to use a one year guideline and suggested as much back in 1989. But Congress rejected adding that provision to legislation during that year. And from what I have been told the IRS is still using that guideline.

I suppose if after filing as a partnership for several years, the "partners" might consider requesting an advance ruling on whether or not they have a partnership.

And after reading Rev Rul 99-6 and PLR 200807005 it seems that a tax free exchange is being encouraged by the IRS, which for me, muddles the situation.

I guess the next time the opportunity presents itself I should do more searching for a qualified "qualified intermediary".

The intermediaries in NH will be even more gun-shy in the future. The state Department of Revenue decided recently not to consider a single member LLC to be a disregarded entity and has decided that if you exchange property and place the replacement property in an LLC, the exchange is totally taxable in NH. The reasoning is that the new owner is not technically the same as the old owner. The State has sent out notices to those who undertook such transactions in 2005 (before statutes expire). As a result many customers of these intermediaries are very upset.

DaveFogel (talk|edits) said:

21 December 2009
I wrote an article a few years ago dealing with the question of how long you have to hold property involved in a §1031 exchange (both the relinquished property and the replacement property) before it is considered held for investment or for use in a trade or business. After analyzing numerous court cases and rulings, my conclusion was that it is more important to establish that the taxpayer intends to hold the exchange properties for investment or for use in a business, as demonstrated by objective facts, than the length of time that the properties are held.

Yt1300inHtown (talk|edits) said:

19 July 2010

Client is in a a family Pship. The land has already been sold and cash distributed. NOW he wants to ask about a 1031.

Its too late right? None of the steps or considerations discussed in this thread were done. Its the classic, act now, consult later client ploy.

Is there anything that can be done this late in the game that I am not aware of?

Kevinh5 (talk|edits) said:

19 July 2010


Yt1300inHtown (talk|edits) said:

19 July 2010
Kev, please elaborate.

I'm joking. Thanks!

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