Acquiring Partnership Interests as Replacement Property

Locating replacement property is the largest concern for most taxpayers involved in a 1031 Exchange. Some Exchangors will even avoid participating in a 1031 Exchange just to avoid the stress of finding suitable replacement property within the 45-day Identification Period.

Section 1031 expressly states that partnership interests are ineligible for 1031 Exchange. But, there are 2 scenarios in which the acquisition of a partnership interest may qualify for 1031.

Acquiring 100% of a Partnership Interests as Replacement Property

Despite the Code’s prohibition on exchange treatment for partnership interests, the exclusion does not apply when the partnership is a disregarded entity at the time the exchange is completed. A disregarded entity is one owned by a single taxpayer. A single-member LLC or limited partnership in which all partnership interests are owned by a single taxpayer can be disregarded entities. One reason for acquiring all of the interests in an existing entity that owns the replacement property is to avoid transfer taxes. Many jurisdictions do not assess a transfer tax on the sale of an existing entity that owns real estate. In such states, significant savings can be achieved. In PLR 200118023 (1/31/2001), the Service held that a taxpayer’s acquisition of the sole membership interest in an LLC that owned the replacement property is treated as if taxpayer received title to the relinquished property directly.

Acquiring a Remaining Partnership Interests as Replacement Property

Another replacement property strategy is when the taxpayer is already a partner in a partnership. In this situation, the taxpayer can acquire all the remaining interest of the other partners. The taxpayer must own all of the partnership interest at the time that the exchange is completed. Rev. Rul. 99-6 dealt with a situation involving a two-member LLC taxed as a partnership. One partner sold all of its partnership interest to the other partner such that the partnership technically terminated under IRC §708, and the LLC became a disregarded entity. The Service stated that the partnership is treated as having distributed its assets in liquidation to the partners, and the purchasing partner is deemed to have purchased the assets deemed to have been distributed to the other partner.

Security 1st Exchange cannot provide tax guidance or advice to any taxpayer. We do offer possible options for you and your tax professional to review to see if it is the best course of action in your specific situation.