1031 Exchange Tips for Tenancy in Common Property

Tenancy in Common Property

A lot of times people own real estate in a partnership or LLC that's taxed as a partnership. If the property goes up in value some of the partners may be inclined to sell the underlying real estate while other partners are not so inclined because they don't want to pay the taxes.

This divergent opinion between the partners can be exasperated if there's been a death of one of the partners and the heirs of the now-deceased step into the partnership with a stepped-up basis and perhaps a more cavalier attitude about selling the underlying real estate. Because they may not have much of a tax burden if the property is sold, they may be less concerned about the tax consequences of a sale.

Setting up a Tenancy in Common

Furthermore, they may not want to be in a partnership with all the other folks. So when this sort of divergent opinion exists it may be a prudent step to bifurcate the ownership of the asset so that rather than having a partnership we would have a tenancy in common. If a sale were to ever occur, the exchange minded folks could be in one entity, and the cavalier folks that have a high basis and are less concerned about taxes would be in a separate distinct tax-paying entity.

When the sale occurs, hopefully we have two sellers on the purchase agreement, and two sellers that are separately 1099’d by the title company. The exchange minded group can set up their proceeds to go with a qualified intermediary and defer their gain, while the cavalier high basis folks that are less concerned with the tax can simply take their share of the proceeds and go.

Give Yourself Time

When do you want to set up this bifurcation? Do you want to set up the split up on the eve of the closing right before you sell the relinquished property? Do you think the IRS will respect a last minute switch? Probably not. The better course of action is to have this conversation amongst the partners early, before there's even a tacit agreement to sell the property and to break up the property well in advance of any proposed sale. Let some time pass after the break up before you actually sell the property. The IRS is much more likely to respect a reconfigured ownership arrangement if it is done well in advance of any sale and some time has passed.

1031 Holding Requirement

Furthermore, remember there's a holding period requirement in section 1031 that the relinquished property must have been held for investment or business purposes. If you do a drop and then a swap immediately you may not have held your property for a sufficient period to satisfy the requirements of 1031.

  • 1031 Hotline: If you have questions about 1031 exchanges of TIC property, feel free to call me at 612-643-1031.

Defer the tax. Maximize your gain.


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