1031 Rules

It is not uncommon when a partnership sells its property, the partners may elect to go their separate ways. Still, many desire to use IRC 1031 to tax defer the tax impact of a gain. The split-up of the partnership and the utilization of IRC 1031 can be structured as follows:

If the partners want to split-up:

The partnership can dissolve, and distribute the property ownership pro-rata into a tenancy-in-common. Under IRC 731, distributions of partnership property is deemed tax-free. Subsequent to the receipt of an undivided interest in the property, each co-tenant may exchange his real property interest for another property interest.

If the partners want to continue their relationship: Each partner can identify a separate replacement property, allowing the partnership to exchange its property for specific replacement properties. After taking title to the replacement properties, the partnership may distribute the properties in a taxfree liquidation of the partners interest.

Depending on the desires of the partners, another option available is the designation of property by each partner, whereby the partnership exchanges its property for the designated property. They will then continue to operate with special allocations of the income or losses to each respective partner.

WHAT HAPPENS IF THE REPLACEMENT PROPERTY IS IDENTIFIED BEFORE THE SALE OF THE RELINQUISHED PROPERTY?

In certain situations, it is likely that a taxpayer may identify the replacement property before the relinquished property is sold. If the seller of the replacement property is willing to extend the closing date in order to sell the property, then a deferred exchange can be completed. If the seller does not agree to an extension of the closing date, the taxpayer may use a reverse exchange.

By entering into a reverse exchange, an unrelated third party to the exchanger acquires and holds the replacement property. This is known as "parking" the property.

The selection of the unrelated third party is often the QI, who will park the property until the seller disposes of it. At that time, the QI will assist in the completion of the exchange by conveying the replacement property to the seller.

There has been some question as to the use of the parking method. Until recently, the IRS had reserved judgment as to whether Section 1031 applies if the replacement property is acquired before the relinquished property is transferred. Recently, however, the IRS issued Revenue Procedure 2000-37, which provides a Safe Harbor for a taxpayer engaging in the parking of property.

The regulation cites a). the qualification of property as "replacement property" or "relinquished property"; and b). the acceptance of the QI as the beneficial owner of the property for federal income tax purposes (as long as the property has been acquired on or after September 15, 2000). As a result of this, we can anticipate that taxpayers may engage in more reverse exchanges.

1031 Tax |