What Is A "Drop & Swap" Exchange?

Often times, real property held by a partnership or limited liability company is subject to a sale but there is disagreement among the partners as to how to handle the sale proceeds. Some investors want to conduct a 1031 exchange while others simply want to sell for cash. To satisfy these competing interests, the partnership or LLC initiates what is known as a “drop and swap” exchange.

In such a transaction, before the exchange the property ownership title is changed to reflect individual partner names and their partitioned interests rather than the partnership or LLC itself. This title change is the “drop.” Thereafter, the exchange occurs and some members defer their capital gains tax while others cash out and pay taxes.

While on its face it all sounds simple, the reality is the IRS is wary of this “drop and swap” strategy and carefully scrutinizes these transactions to determine if the “held for” requirement has been met. From the IRS’s point-of-view, when the title is changed from the partnership to the individual members, the clock for the holding period is reset to zero. This often catches unwary “droppers and swappers” out and jeopardizes the validity of the entire exchange.

To find out how we can help you find and close on your next 1031 exchange property or to learn more about the exchange process and our qualified intermediary services, please visit our website.