A 1031 exchange provides investors with excellent tax advantages, but it also comes with many rules. If you own a property as an individual and want to perform a 1031 exchange into a joint venture or partnership, does anything in the 1031 exchange rules prevent you from doing that? Let’s dive in to find out.
Partnerships, LLCs, and Trusts
Nothing in the 1031 exchange rules prevents a partnership, LLC, or trust from executing a 1031 exchange. These are entities exchanging from one property to another as the same entity. In other words, the entity isn’t starting as a partnership and ending up as a trust on the other side of the exchange.
Whether as an individual or some entity structure, the 1031 exchange is allowed if the entity relinquishing the original property is the same entity acquiring the replacement property.
The title question of this article asks if you as an individual can 1031 exchange into some other entity. As stated above, the answer is no. The entity must be the same throughout the 1031 exchange process.
Dissolution Of an Entity Before a 1031 Exchange
The problem with joint ventures such as a partnership or LLCs is that there may be disagreements between the people within the entities. This is problematic if some want to execute a 1031 exchange while others don’t. However, there are ways to get around this issue.
Let’s say three people are in a partnership, which owns the property. To clarify, each person in the partnership owns an interest in the partnership while the partnership owns the real estate. One person wishes to sell the property outright, while the other two want to perform a 1031 exchange.
The two individuals can’t perform a 1031 exchange while the other sells his interest. The reason is that partnership interests are excluded from the 1031 tax deferral. Per 1031 exchange rules, the partnership participates in the 1031 exchange, but your partnership interest does not.
The solution is to first convert the partnership interest into real property interest. Now the three partners own property as TIC (tenants-in-common) co-owners. Each one owns a third interest in the property. This technique is also known as a drop and swap. The partnership is dropped and swapped for a TIC.
To meet IRS qualifications, the individuals need to hold on to the property for a period of time to show that it is an investment. A general guideline is for the property to be held for at least a year (as a TIC in the above example). This means the individuals cannot drop and swap then immediately execute a 1031 exchange on the property.
When entities are involved, and there are disagreements about performing a 1031 exchange, it is best to work with an attorney and real estate tax advisor to ensure all 1031 exchange rules are followed.