I have a tax question regarding the exit of 1 of 3 partners from a real estate partnership and would really appreciate any input:
ABC Realty (a general partnership) has 3 equal equity partners (A, B & C). ABC Realty's assets are 5 rental properties (no mortgages) and some cash. Each property is in its own LLC with ABC Realty as the sole member. Partner A wishes to gradually cash out of the buildings and defer the gains with 1031 exchanges. Partners B & C would remain owners of the properties, preferably in the existing LLC's. Is it possible to structure this to qualify for a 1031 exchange - if Partner A is bought out of each LLC (and building) separately (rather than a valuation and exit of the partnership as a whole)? From a tax perspective, can we do a deed from each LLC to A, B & C individually (no change in beneficial owner) and then another deed from A, B and C back to the LLC after transferring ownership of the LLC from ABC Realty to Partners B & C? Then when all properties have been transferred back to the LLC's (now owned by B & C), dissolve the partnership and distribute remaining cash to everyone. I realize the transfers from A, B & C back to the LLC's would have transfer tax consequences for the 1/3 change in beneficial owner. This strategy would entail an appraisal of each building (FMV split 3 ways evenly) rather than a valuation of the partnership as a whole in order to avoid any minority discount hit for Partner A.
@Amy O'Shea , I get where you're coming from. But it sure feels step transactionish. And the issue of holding intent comes into play at several points. But that being said with enough time I think you could get there from here.
1. Biggest issue you've identified - Investor A has to own real estate to sell and 1031. So dissolving the LLC and placing the real estate into A Band Cs hands as tenants in common would allow A to sell their tic interest in the
real estate and 1031. Intent in the dissolution would be key to determining how long to wait before sale. A change of entity followed by a sale and 1031 is always very suspect.
2. But second biggest issue also rears its head. A ends up owning real estate but sells it back to B &C who then place it back in the partnership. That's where it feels like a step transaction just took place.
3. And third issue then is who really is the tax payer of those properties. I'm thinking it might be the general partnership owning 100% of the membership interest of the LLCs regardless that the LLC is on deed. In that event the partnership not the LLC is the tax payer for the real estate. Unless each LLC is filing it's own returns. But even then the individuals A B and C are still removed from actual ownership by the LLC and the partnership.
If the partnership didn't want to hold onto the properties I would recommend that the partnership do a 1031 exchange and purchase properties satisfactory to all and then after letting the dust settle dissolve the partnership and distribute the properties to the individual members. Or offer one or more of the properties to A in exchange for his membership interest in the partnership. B and C could also then either stay with the partnership or if dissolved, at some point recombine and move ahead sans A . A would have new property of their own.
But since the partnership wants to stay active And since the partnership doesn't want to sell the properties (it only wants to get rid of A), there's not much of a 1031 scenario available.
Some layman thoughts - Is A's capital account such that B & C could simply exchange his membership for cash? Could the partnership simply buy some real estate acceptable to A and then distribute it to him in exchange for membership interest? A sale of interest on an installment sale might be a possibility as well. It's not a complete a tax deferral as a 1031 but could mitigate some burden for a while.