Property Owned Through a Partnership Can Complicate a 1031 Exchange

Partnerships Were the Entity of Choice
Real property investors who acquired real estate during the 1960s, 1970s and into the 1980s often set-up a general partnership or limited partnership in order to acquire and own the real property when multiple investors were involved. The general partnership (GP) or limited partnership (LP) were the entities of choice.

Today Partnerships Can Be a Problem
The general partnership or limited partnership made a lot of sense back then when multiple real estate investors were involved buying property together, especially since limited liability companies (LLCs) had not made their debut yet.

However, today, general partnerships and limited partnerships can be a significant problem when investors are trying to dispose of real estate that is owned in a partnership.

Real Property vs. Personal Property Interest
The issue is actually quite simple, but can become very complex. The real estate investor does not really own an interest in real estate. He or she owns a general or limited partnership interest in the general or limited partnership. The partnership interest is a personal property interest; it is not a real property interest. The partnership actually owns the real estate, and this is where the problem lies.

Sale of Property Held in a Partnership
The property is actually owned by the general or limited partnership. The partnership is the owner/taxpayer. Therefore, the partnership is the seller of the real property when the property is sold (not the investors/partners).

Partnership Can Complete a 1031 Exchange
The investors/partners merely receive a distribution of the cash proceeds from the partnership upon the closing of the sale transaction. The investor/partners did not sell an interest in real estate; the partnership did. So, the partnership can structure and complete a 1031 exchange and acquire replacement investment property. The replacement property must be acquired and owned by the partnership.

Partners Do Not Want To Stay together
The problem that is quite common today is that most of the investors/partners no longer want to stay together and want to terminate the partnership upon sale of the property and each go their separate ways. This creates a complex problem for those investors/partners that want to complete a 1031 exchange. It requires advanced tax planning because the investors/partners do not own an interest in real estate.

Solutions
You might be sweating a little bit right now if you own property in a general or limited partnership, but don't panic yet. There are solutions to this problem. Generally, the safest solutions need about 24 months in order to implement them correctly and be able to complete a 1031 tax deferred exchange. There are other solutions that may work and will carry some degree of risk, but are viable options when you do not have 24 months to plan ahead.

I will be discussing these various options in my next few blog posts, so stay tuned.