Many people own property in LLCs or partnerships and they want to do a 1031 exchange on their specific interest in the partnership. That causes a lot of problems because partnership and LLC ownership interests are excluded from 1031 treatment.
Tenancy in Common
If you have a time machine you might want to go back in time and change the ownership of your relinquished property to a tenancy in common so you could own your piece of the pie as a co-tenant rather than a partner.
Some people want to convert their partnerships to a tenancy in common right before they close on the sale of their relinquished property. That can sometimes work, especially if the person that’s jumping out of the partnership isn’t the one that wants to do the 1031 exchange.
An LLC Example
For example, let’s say that 55% of the partners want to stay inside of the partnership and they’re going to conduct an exchange under the name of the old surviving partnership. But 45% of the partners want to jump out of the LLC and become tenants in common and they just want to take their cash and pay their taxes. That’s a safer way to construct a drop-and-swap because the old taxpayer (the partnership that’s owned the property all these years) is the entity that does the exchange.
The more problematic situation occurs when everyone wants to break up and the partnership is going to terminate because more than 50% of the ownership leaves in a 12 month period.
Planning and advanced thinking is the name of the game. If you’ve got clients that are in partnerships or LLCs that have property they may be selling in the near future, it’s best to get ahead of this issue. Break up the partnership way in advance. Even before you have a tacit agreement to sell, reconfigure the partnership or LLC to a tenancy in common.
- 1031 Hotline: If you have questions about 1031 exchanges of partnership or LLC membership interests, feel free to call me at 612-643-1031.
Defer the tax. Maximize your gain.
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