When Can you Buy Out a Partnership or LLC Interest to Complete a 1031 Exchange?

We get a lot of questions about 1031 exchanges involving partnership or LLC interests. Is it possible to buy out a partnership or LLC interest to complete a 1031 exchange? That’s our topic for this article.

Partnership & LLC Interests

Normally partnership or LLC interests (or interests in other business entities such as corporations) are not considered like-kind to real estate for the purposes of completing a 1031 tax-deferred exchange.

However, Private Letter Ruling No. 2008-07005 (PLR 200807005) says that receipt of 100% of a partnership, consolidating ownership in one taxpayer is the same as an acquisition of a "disregarded entity" and as such would be treated as an acquisition of the underlying real property interest for 1031 exchange purposes. 

CPEC1031

It’s always a good idea to discuss these situations with an experienced qualified intermediary who can walk you through the process to ensure success. At CPEC1031, LLC, we have been providing 1031 exchange services for the past twenty years. Let us help you defer taxes when selling real estate. You can find us at our main offices in downtown Minneapolis.

• Start Your 1031 Exchange: If you have questions about 1031 exchanges, feel free to call me at 612-643-1031.

Defer the tax. Maximize your gain.

© 2020 Copyright Jeffrey R. Peterson All Rights Reserved

1031 Exchanges with Partnership Ownership Interest

If a party owns investment real estate in a partnership and the other parties buy out one member, can that member 1031 exchange those proceeds to another "like kind" property?

Generally, an interest in an entity such as a corporation, partnership or LLC cannot be exchanged.

Section 1031 allows for the tax deferred exchange of real property…but stocks, bonds, and interests in businesses (or more specifically business entities) which cannot be exchange under Section 1031.

Consider Tenancy-in-Common

Sometimes it is possible to change or reconfigure the ownership of the property to convert a partner/member into an owner of a tenant-in-common interest (or portion) in the underlying real property. For example a partner/member may be redeemed out of the entity in exchange for a deeded tenant-in-common interest in the underlying real property…so that they may be able to later sell/exchange out of their tenant-in-common interest in the underlying real property through a 1031 exchange.

Typically, one should hold their interest in the Relinquished Property for a substantial period of time to satisfy the “holding period” for qualification under Section 1031. 

The code Section states that:

No gain or loss shall be recognized on the exchange of real property held for productive use in a trade or business or for investment if such real property is exchanged solely for real property of like kind which is to be held either for productive use in a trade or business or for investment.

Oftentimes once a reconfiguration of ownership has been accomplished to convert a former partner/member into a tenant-in-common owner there is a new tenant-in-common agreement created among the co-owners of the real estate that states the mutual co-ownership of the property is not a joint venture or partnership arrangement.

• Start Your 1031 Exchange: If you have questions about 1031 exchanges, feel free to call me at 612-643-1031.

Defer the tax. Maximize your gain.

© 2020 Copyright Jeffrey R. Peterson All Rights Reserved

1031 Exchanges of Partnership & LLC Member Interest

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.

• Start Your Exchange: 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.

© 2016 Copyright Jeffrey R. Peterson All Rights Reserved