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What to consider when structuring 1031 partnership exchanges

Over the last few decades, we’ve learned that partnerships can cause significant planning problems for partners and their tax advisors. Partners are not permitted to sell or dispose of their partnership interest and subsequently defer the payment of their capital gain taxes by acquiring like kind replacement property through a 1031 Tax Deferred Exchange transaction.

Partnership interests are specifically excluded from 1031 Exchange treatment under Section 1031 of the Internal Revenue Code. Partnership interests are personal property, and are not considered to be like kind to the acquisition of real estate, even though the underlying assets held within the partnership are in fact real property.

However, with proper advanced tax planning, partners can restructure their ownership position so that they could qualify for a future 1031 Tax Deferred Exchange transaction involving the underlying real estate held in the partnership entity.

The partners may either sell their individual interests in the partnership, or the partnership can sell the real property and distribute the cash to the underlying partners so that each individual partner can go their separate way. There is no 1031 Exchange completed here. Neither solution is particularly desirable, as both have undesirable income tax consequences.

The sale of partnership interests are specifically excluded from tax-deferred exchange treatment under the rationale that a partnership interest is a personal property interest and not a real property interest, so more complicated structural solutions are required when partners desire to go their separate ways and some or all of the partners wish to structure and complete a 1031 Exchange.

The following structural solutions should be considered as possible strategies provided the partners have sufficient time to properly plan and implement these strategies and are willing to work together in order to do so.

The various strategic solutions include the following:

If a partner or group of partners disposes of their partnership interests they cannot defer their income tax liabilities by completing a 1031 Exchange because interests in a partnership are personal property interests and cannot be exchanged for an interest in real property.

For further variations on the strategies described above, contact a ShindelRock tax professional [1] today to determine what options might be suitable.


http://www.exeter1031.com/article_1031_exchange_partnership_interests.aspx [2]