Owning appreciated real estate in an entity can create problems when it comes time to sell the property. Challenges arise if there are multiple partners/shareholders with different goals upon sale. For example, if two people own appreciated land in partnership and one partner would like to do a 1031 exchange and one partner would like to pay tax and take the after-tax proceeds, there is a problem. The IRC 1031 exchange provisions require that the entity selling the relinquished property must be the same entity taking title to the replacement property. So in this case, the partnership would have to do the exchange and each partner could not do his or her own exchange. Fortunately, there are solutions to this problem.
Solution 1: Drop and Swap
Prior to a sale, the partnership could distribute (drop) the property out of the partnership and each partner would take title to their ownership in the property as tenants-in-common. This would allow each partner to then perform a 1031 exchange (swap) for their ownership in the property if they so desired.
To comply with IRS rules, it is important that the distribution of the property out of the partnership take place well in advance of a sale. Please consult your CPA and/or attorney regarding this matter.
Solution 2: Swap and Drop
Using this strategy, the partners could each identify their own separate properties they wish to own. The partnership would perform the exchange (swap) and at a later date, preferably longer than one year, the partnership could distribute the property (drop) to each partner “in-kind”. Once again, consult your CPA and/or attorney regarding the use of this strategy.