1031 exchange:
Partnership Can Create Unique Problems in 1031 Exchanges

A partnership holding investment real estate can exchange, as a partnership, relinquished real estate for replacement real estate under Section 1031. The title to both the relinquished property and replacement property must be held in the name of the partnership. An investor owning a partnership interest may not exchange the partnership interest for a partnership interest in another partnership. Exchanges of partnership interest are specifically excluded from the provisions of section 1031. This is true even if the only assets of the partnership are real estate. Often real estate is held in the names of co-owners rather than in the name of a partnership. Co-owners sometimes mistakenly identify themselves as partners in real estate when technically they are co-owners.

When multiple owners are involved it is important to investigate whether they are co-owners or partners. A good indication is whether partnership tax returns have been filed. Co-owners can exchange their fractional interest ownership in real estate for like kind real estate with or without the participation of the other co-owners. However, when certain partners within a partnership wish to exchange their investment while other partners instead wish to receive their cash proceeds this creates perplexing 1031 exchange problems.

In two separate rulings, the IRS has denied tax deferred exchange treatment when:

1. a partnership distributed fractional interests in real estate to the individual partners and some partners attempted to exchange those newly acquired real estate interests, and
2. a partnership performed a 1031 exchange and then immediately distributed real estate interests out to the various partners into their individual names. Summary: Partnership taxation is one of the most complex areas of the Internal Revenue Code. Partnership taxation rules under Section 1031 are also complex. As a realtor listing partnership property, plan the exchange from the inception of the transaction.

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