Partner Buying Me Out. Can I 1031 Exchange Into Other Real Estate?

Three (3) investors own an investment property together.  They own the property as tenants-in-common, or co-owners, are each individually on recorded title to the property, and each report their own individual interest in the real property on their own income tax return.

Partner To Buy Out Remaining Partners

One of the partners now wants to buy the other two (2) co-owners of the real property out so that he or she now owns all of the property.  The two (2) partners will agree to be bought out as long as they do not have any income tax liability because of the sale.

Can Remaining Partners Structure 1031 Exchange?

The question is whether the two (2) partners that are being bought out can structure and complete a 1031 Exchange in order to defer their capital gain taxes into the purchase of another property. 

Generally, the answer is yes, because they each own a tenant-in-common interest in the real estate, are each individually on recorded title and each treats and reports their interest in the real property on their own income tax returns. 

The two (2) remaining partners can each decide individually to cash out, to structure a 1031 Exchange and go their separate ways, or to 1031 Exchange into the same replacement property and remain co-investors in the new property. 

Beware Of The Partnership Interest

This was a nice clean question and answer scenario.  It was a brief discussion that I had on the phone today.  There are numerous issues here that could change the answer to the question, so you should always have your legal or tax advisor review your specific situation.

The biggest area of concern is when an individual does not own an individual interest in the real estate, but actually owns and treats their ownership as an interest in a partnership. 

Holding Real Property in a Partnership or Multi-Member LLC

This is just a quick note about issues involved with property held in a general partnership, limited partnership, or multiple member limited liability company and the complex problems that can arise when the underlying partners want to dispose of the real estate and subsequently structure a 1031 Exchange.

It is important to note that the entity itself (i.e. the partnership) is the owner of the property, and therefore any 1031 Exchange structure should be completed at the entity level. The underlying partners do not own an interest in real estate. The partners own an interest in the partnership (partnership interest), which is personal property and not real property.

There are solutions for these scenarios, but it generally takes advanced, proactive planning in order to properly structure a solution. I would recommend that you speak with your legal and tax advisors today if you already own property in a partnership or other separate entity in order to discuss how to restructure your ownership position now before it becomese a problem at the time of actual disposition.

Can I Buy a Piece of a Property as Part of My 1031 Exchange?

This question can take many forms. The most common are as follows:

• I own property together with another party. I'm in the middle of a 1031 tax deferred exchange. Can I identify and buy the 50% of the property that is owned by the other party as part of my 1031 tax deferred exchange so that I now own 100% of the property?
• There is a small group of friends that want to buy property together. We would each end up owning about 20% of the property. Can I identify this 20% and buy it as part of my 1031 tax deferred exchange?
• I attended a seminar on buying/investing in tenant-in-common investment properties where I would buy a fractional interest in a large commercial property. Does this fractional interest qualify as replacement property for part of my 1031 tax deferred exchange transaction?

The answers is yes to all of these questions.

The requirement is that the investor who sold real estate through a 1031 tax deferred exchange must also acquire like-kind real estate as his or her replacement property in order to complete a successful 1031 exchange. The replacement property does not have to be 100%; a fractional interest will qualify with no problem.

Your professional 1031 tax deferred exchange Qualified Intermediary can help you identify a fractional interest in real property when you are completing your identification form during your 45 day identification period.