A partnership may undertake a tax-free exchange on qualifying assets it owns under section 1031. One of the requirements to meet the like-kind exchange rules is that the entity that sells the relinquished property must be the same entity that acquires the replacement property. Where the property is owned by a partnership or an LLC with multiple partners, that entity is viewed as the exchanging entity. However, a partner's interest is specifically excluded from a tax-free exchange transaction.
In many cases, a partnership wished to dissolve and the owners desire to go separate directions. This may cause an issue with a partner that wishes to continue investing in real estate and wants to use a 1031 exchange to defer their capital gains tax. With careful, forward planning, an interest in a partnership can be exchanged with careful, forward planning.
By converting an interest in a partnership to real property that is distributed to a partner - who then completes the exchange - the partner may qualify for a like-kind exchange under section 1031. The article Partnership & Co-Ownership Issues Issues briefly explains two techniques used to accommodate a 1031 exchange where partners desire different directions.
An increasingly popular investment vehicle for real property investors who wish to defer capital gains via a 1031 exchange and own real property without the management headaches is a tenancy in common ownership (known as a TIC). Exchangers may have difficulty locating and closing a suitable replacement property within the 45 day identification period and the 180 day closing period. Tenant-in-common ownership opportunities potentially reduce the risk of not completing a successful exchange.
Although TIC ownership has been used for many years, its popularity has been increasing dramatically due to a 2002 IRS ruling that allowed 1031 exchange participants to replace their relinquished property with a tenant in common ownership interest. For further information in 1031 exchanges and TICs, please see What is a TIC?
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