When a single partner seeks to exit a real estate partnership in proximity to a 1031 exchange, there are various options for the partnership to consider, including but not limited to the three listed below. The partnership should consult with their tax advisor to determine the most suitable approach for their situation. Given the range of potential considerations, some of the following options may be less conservative than others. The options outlined below assume that the partnership will continue its existence after the partner(s) exit.

OPTION 1: Distribute out a tenancy in common (TIC) interest to the departing partner, usually a minority partner, and continue as a partnership. This is a variation on the “Drop and Swap” and is generally used to redeem a partner. aka, the “drop and swap lite”.

• Retitle the distributed share into the name of the departing partner and create a new Co-Ownership Agreement between the partnership and the new co-owner. The Partnership Agreement should allow for distribution of property other than cash.
• The new co-owner (exiting partner) will report their share on schedule C of their personal tax return. Preferably on individual return for year prior to sale of the property.
• The new co-owner (exiting partner) can later sell their share of the real estate for cash or do an exchange when the building is sold.
• The partnership tax return for the year of distribution should reflect the departure of the partner.
• The partnership will stay together and will only have to purchase property for its share of Net Sales Price.
• Not good for unfriendly partners due to TIC rights issues.
• The loan should reflect the ownership change. Lender approval of title change can present a hurdle.
• Taxpayers must weigh tax impact with an advisor if done in connection with the sale of the property.

OPTION 2: Existing Partners or New Partner buys out the Departing Partner (Partnership continues).

• Assumes departing partner wants to cash out and pay their tax and doesn’t want to do an exchange.
• Individual buying partners increase their cost basis in their shares of the partnership and may file for a Section 754 Election.
• The partnership tax return for the year of sale should reflect the restructuring of the partnership.
• The partnership can stay together and hold the building or sell and exchange it.
• Partnership must purchase Replacement property for 100% of Net Sales Price for a successful exchange.
• Lender restrictions may still apply.
• Good for ending unfriendly relationships.

OPTION 3: The Partnership buys out the Departing Partner for Cash or Note(s) secured by the property.

• Assumes departing partner will cash out, pay their taxes, and will not exchange.
• Basically, there is an installment sale by Partnership to retire departing partner’s shares.
• Departing partner(s) receive an installment note until property relinquished, at which point they cash out.
• The partnership tax return for the year of sale should reflect the restructuring of the partnership.
• The partnership must purchase replacement property using 100% Net Proceeds for a successful exchange.
• The partnership can stay together and hold the building or sell and exchange it.
• An ideal strategy for ending unfriendly relationships.

Legal 1031 Exchange Services, LLC does not provide tax or legal advice, nor can we make any representations or warranties regarding the tax consequences of your exchange transaction. Property owners must consult their tax and/or legal advisors for this information. Our role is limited to serving as qualified intermediary to facilitate your exchange. © 2021, Rev. 2024 Legal 1031 Exchange Services, LLC. All rights reserved.