1031 Exchange into Partnership?

Question

Hello,

Can a person take 1031 exchange monies and partner with another investor on a like property? If so, how would this look and be set up? Say I have $100k to 1031 and want to buy a property with a partner that also brings in $100k to invest.

Thanks

Bill Exeter · Answer

I wanted to clarify one of the comments in this string:

You cannot go from full to a partial owner as this is strictly against IRS regulations.

This comment is slightly misleading, although it was not meant to be.  An investor can not sell real estate that he or she owns in their own name as an individual and then 1031 Exchange into another property by acquiring an interest in a partnership or by investing in a new partnership that is being formed to buy the new property.  This is treated as if the investor bought a partnership interest (not real estate) and then the partnership bought the real estate, and it would not qualify for 1031 Exchange treatment.

However, an investor can sell their existing property that they own 100% of and then subsequently acquire a fractional or percentage (partial) interest of another property such as an XX% undivided interest as a tenant-in-common.

This is an important clarification, and not always an easy one for investors to fully grasp.  Investors often use the term partnership when they are not really referring to a formal partnership but a bunch of investors that are buying property together as tenants-in-common (could also be done through a land trust or Delaware Statutory Trust).

Ebere Okoye · Answer

Yes you may. Partial interests qualify for exchanging within the scope of Section 1031 of the Internal Revenue Code. However, if your interest is not in the property but an interest in the partnership which owns the property, your exchange would not qualify. This is because partnership interests are excluded from Section 1031. But don't be confused! If the entire partnership desired to stay together and exchange their property for a replacement, that would qualify.

Another caveat, those individuals or groups owning partnership interests who desire to complete an exchange, and have for tax purposes, made an election under IRC Section 761(a) can qualify for deferred gain treatment under Section 1031. This can be a tricky issue!

Steven Hamilton II · Answer

A partnership itself can do a §1031 exchange; however, you cannot do a 1031 into a partnership interest.

-Steven the Tax Guy

Your guide to IRS Laws, Rules and Regulatiosn

Steven Hamilton II · Answer

Ebere and Fern,

That was a great cite from: "http://www.1031exchangemadesimple.com/1031-faq.html"; however, that does not answer her question. The question is if she can take a property in which she owns 100% and can use the proceeds to fund a partial interest in a NEW partnership.

You cannot go from full to a partial owner as this is strictly against IRS regulations.  In some cases you could be considered to have contributed the property to a partnership; however, those laws are rather distinct and specific; it also typically requires you to contribute the property to the partnership before it is exchanged.

Here from IRS Publication 544:

"Partnership Interests

Exchanges of partnership interests do not qualify as nontaxable exchanges of like-kind property. This applies regardless of whether they are general or limited partnership interests or are interests in the same partnership or different partnerships. However, under certain circumstances the exchange may be treated as a tax-free contribution of property to a partnership. See Publication 541, Partnerships."

Here is the IRS Publication 544 about Like-Kind Exchanges(Code Sec 1031): http://www.irs.gov/publications/p544/ch01.html#en_US_publink100072371

Michael Penny · Answer

I think I have a slightly nuanced version of the original question.  If I used 1031 funds to buy into a new property that I solely own and it has been less than 12 months since I have owned it, can I allow someone else to buy into this property with me?  If not, is there a timeframe where I can?

@Dave Foster

Dave Foster · Answer

In a Tenant in common scenario each person owns a piece of real estate that is really just a % of a larger piece.  Any lender is going to require all owners to sign when securing one piece of property.

I spose you can allocate all of those things anyway you want.  But the most typical is to align them with the % of ownership.  If a property is worth $1 mil and 4 owners want to own equally then each of them own 25% of a million dollar property as tenants in common (the deed will be recorded as such.  Then each would usually have 25% responsibility for expenses and get 25% of cash flow, bring 25% of the down payment etc etc.

Any debt is on the property as a whole and the lender wants to be able to look to all the borrowers for satisfaction.  That is why all sign and all are responsible in the whole for the debt.

Dave Foster · Answer

@Kacey W, this chain got deep in the weeds from your original question.  And I think it was your use of the word "partner".  I see this frequently.  Partner could mean members of the same registered partnership entity such as a limited partnership or general partnership.  But there's also partners where you and me each throw $100K in the hat and buy a $200K property together.  I think that may be what you're asking.

Since your money came from a 1031 exchange for a property that you sold then you as the exchanger have to take title to at least $100K of the new real estate.  Your "partner" could take title to the remaining interest.  You would both be 50% tenants in common on that new property.

No problem at all that way.

@Cindy Chow, as long as you the exchanger are taking a Tennant in common interest in real estate that equals or exceeds the amount that you sold and as long as you are using all of your proceeds in the purchase.  The ratios and allocations of cash, debt, ownership do not matter.  I think however that this would be an important lender consideration if leverage were being obtained.

Like Kacey's example above.  She could use her exchange which was $100K cash and her partner could be the guarantor (again pending lender approval) or at least originator or co borrower of the $100K loan for the balance of the 200K purchase.  as long as the exchanger purchases at least as much as they sell and uses all the exchange proceeds that would be fine.

Bill Exeter · Answer

Hi @JR M.,

Yes, you can certainly sell your relinquished property (100% ownership as an individual) and then 1031 Exchange into replacement property that is partial owned by you as long as the individual as a direct interest in the property such as a tenant-in-common interest.  This would qualify.

However, the immediate transfer from an individual into an LLC would likely be classified as a step transaction and treated as if the taxpayer really bought a partnership interest rather than an interest in real estate.

There are some cases provide guidance that seems like you could do this such as Magneson v. Commissioner, but that is an old case under California's old Uniform Partnership Law, which has since been updated/revised.  There would be some degree of risk if the contribution was completed immediately after the 1031 Exchange.

James L. · Answer

Is it possible to buy a property in an Llc? Say a wholesaler has it tied up under contract and he sells you the Llc/ deal, is that ok? Than can they add partners in later?

Jason Clendenen · Answer

Is it possible to buy into an LLC before the 1031? Or after? I understand that the 1031 exchange itself requires the same taxpayer to be on both properties, but if you bought into the LLC prior to the 1031 (or potentially after), then the LLC itself would still be making the transaction with both names on both properties?

1031 Exchange into Partnership?

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