What does NOT Qualify for a 1031 Exchange?

1031 exchange business interest

Not all property is entitled to 1031 tax treatment. Some assets are excluded outright in section 1031 a(2), such as stocks, notes or evidences of indebtedness, and interest in a trust. Other property doesn’t qualify because it’s not held for business or investment purposes.

Partnership Interest

If you’re in a partnership that owns real estate, your partnership interest cannot be exchanged in a 1031. The partnership itself can do an exchange, but you can’t do an exchange on your interest in the partnership. That’s why a lot of shrewd investors are refraining from buying properties in partnerships and instead opting to title the property as tenants in common.

Tenants in Common Example

Here’s a quick example that shows the benefits of a tenants in common setup. Bobby, Susie, and Steve have a partnership and want to purchase some property. However, to qualify for a 1031 exchange, they purchase a property as tenants in common rather than in the Bobby, Susie, and Steve partnership. That gives them the most flexibility to separately do 1031 exchanges when they sell.

If you do buy property in a tenancy in common, make sure that your CPA is not filing a partnership tax return for all co tenants. This is a common practice because it’s easier to do than to file separate returns for each co tenant. But in order to preserve the maximum flexibility for a future 1031 exchange you want to continue to walk like a duck and talk like a duck.

If you want to have the state-law liability protection of an entity, such as a limited liability company (“LLC”), each co-tenant can form their own LLC to take title to their interest in the real property.  The property can be held by each co-owner via a single member LLC that is disregarded as an entity separate from its owner (unless it elects to be taxed as an association or corporation). The sole owner of an LLC which is disregarded for tax purposes is considered to be in the same position economically as if he/she had taken title in his/her own individual name. 

  • 1031 Hotline: If you have questions about what does not qualify for a 1031 exchange, feel free to call me at 612-643-1031.

Defer the tax. Maximize your gain.

 

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