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Drop & swap: Like-kind exchange tax planning

March 18, 2015 / 3 min read

In order for a disposition of property to qualify for Section 1031 like-kind exchange treatment with no gain or loss recognition, the exchanged property and the replacement property are both required to be held for productive use in a trade or business or for investment by the taxpayer doing the exchange, and 100 percent of the sale proceeds need to be reinvested in the qualifying like-kind replacement property.

In the case of property held by a partnership, the partnership is considered the taxpayer in the exchange transaction — not the partners themselves. Statutorily, like-kind exchange treatment is not available for exchanges of partnership interests. Therefore, when some, but not all, of the partners want to reinvest their shares of the sale proceeds and obtain like-kind exchange treatment, those partners desiring an exchange typically will need to hold undivided interests in the property through a tenancy in common arrangement. This arrangement allows individual owners of the property to determine whether to do a like-kind exchange, defer their share of the gain, and to select their own replacement property.

It’s important to meet certain practical and IRS-specified conditions when establishing a tenancy in common. In Revenue Procedure 2002-22, the IRS provides the criteria that it will require in order to provide a private ruling request to taxpayers who want assurance that their co-ownership of rental real property will be treated as a tenancy in common. Although the vast majority of property owners won’t request such a private letter ruling, this Revenue Procedure does provide the criteria that should exist in order to have confidence that this co-ownership arrangement will be treated as an ownership interest in real property and not be treated as an ineligible partnership interest for income tax purposes.

In addition to the IRS requirements that should be present in these tenancy in common arrangements, the following economic considerations need to be addressed carefully:

Plante Moran can assist you in addressing these like-kind exchange tax planning and economic concerns to give you the best chance of having your exchange respected by the IRS. For more information, give us a call.

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