Revenue Ruling 99-6 & 1031 exchange into a partnership

I don't know how I can be in this industry for 30 years and not have known something so "basic".

Apparently, in a 2-partner partnership, one partner can buy out their other partner as replacement property in a 1031 exchange.

Are there any caveats here? I assume the same holds true for an LLC.

One caveat would be that you have never heard of it before. Neither have I.

Same here. I scanned the RR and don't see how you came to that conclusion, but it is late and I only scanned it. Or maybe I am misunderstanding the transaction you are proposing?

The only way this works is as a "drop and swap".
Partnership interests are explicitly disqualified from 1031 exchanges.

I was under the impression that only real estate qualified these days. I guess the partnership could sell the real property to a partner as a replacement property, then liquidate? Or maybe sell the half the buyer doesn't own while distributing the half he does?

But I'm pretty sure the partnership interest itself does not qualify.

Thank you for the responses. It's nice to know I wasn't the only one in the dark on this tidbit.

It is considered a deemed drop & swap.

Situation 1. A and B are equal partners in AB, an LLC. A sells A’s entire interest in AB to B for $10,000. After the sale, the business is continued by the LLC, which is owned solely by B....

Under the analysis of McCauslen and Rev. Rul. 67–65, for purposes of determining the tax treatment of B, the AB partnership is deemed to make a liquidating distribution of all of its assets to A and B, and following this distribution, B is treated as acquiring the assets deemed to have been distributed to A in liquidation of A’s partnership interest

Not authoritative, but if you Google it, you will find many 1031 exchange companies saying it's OK

It is considered a deemed drop & swap.

That position sounds reasonable assuming the exchange eliminates the MMLLC into a DRE as Situation 1 99-6 lays out.

Have you heard the "OTA Case No. 18011715" Sharon Mitchell case? The OTA is in favor of the taxpayer for the drop-and-swap case. However, in April 2021, the taxpayers lose the case.

I remember I was told that drop-and-swap is okay but swap-and-drop is not.
I don't remember exactly where I learned about it.




From Checkpoint library:

In April 2021, a panel of the California Office of Tax Appeals, in the Matter of the Consol­idated Appeals of S. Kwon et al, held that tax­payers who attempted a "swap -and-drop " transac­tion were taxable because the substance of the transaction did not satisfy the requirements of Section 1031. This decision illustrates the impor­tance of sound factual development and knowl­edgeable representation because, when the facts are fully considered, the arguments made by the Franchise Tax Board are less than persua­sive. Because the OTA was persuaded to apply the substance-over-form analysis found in the vener­able Court Holding case, taxpayers are reminded of the need to be careful in structuring swap -and-drop transactions, involving conversion from sep­arate to partnership ownership, just as they must be careful in structuring the more common drop -and-swap transaction, involving conversion from partnership to separate ownership by partners. (R. Lipton & L. Weller, 49 Real Estate Taxation, No. 2, 20 (1st Quarter 2022).)

In the case in the OP, even if we structured it as an actual drop and swap, there would be no problems because the person receiving the drop is not the exchanger. They are the seller.

I guess this transaction would also work in a partnership with more than just 2 partners. The key component is that the exchanger is buying out all of the other partners.

Form matters in this transaction.
They would have to actually change title properly prior to the swap/buyout to align the form with the substance.
Without that step in between, I think you fail on form.

Capt, I assume you are referring back to the discussion in the OP. See Post #6 with the text from the RR. The IRS deems this transaction to be an asset distribution from the partnership followed by an asset sale between partners.

I agree w CaptCook. Plus the IRS at times fights drops and swaps. Within the last year, an atty who assists with lots of 1031 exchanges told me that you want to put at least 2 years between the time of the drop and the swap.

A transaction that is a "deemed" drop and swap would be even riskier than doing the actual transaction.

What's the risk to the buyer? Agree seller would have potential problem if they wanted to exchange into new property.

I agree w CaptCook. Plus the IRS at times fights drops and swaps. Within the last year, an atty who assists with lots of 1031 exchanges told me that you want to put at least 2 years between the time of the drop and the swap.

A transaction that is a "deemed" drop and swap would be even riskier than doing the actual transaction.

I agree with Jessica on the timing risk here as well.
To reiterate a bit, in substance, this is the purchase of a partnership interest. To get it to fly, the form had better be spot on.

Thank you for the responses. It's nice to know I wasn't the only one in the dark on this tidbit.

It is considered a deemed drop & swap.

Situation 1. A and B are equal partners in AB, an LLC. A sells A’s entire interest in AB to B for $10,000. After the sale, the business is continued by the LLC, which is owned solely by B....

Under the analysis of McCauslen and Rev. Rul. 67–65, for purposes of determining the tax treatment of B, the AB partnership is deemed to make a liquidating distribution of all of its assets to A and B, and following this distribution, B is treated as acquiring the assets deemed to have been distributed to A in liquidation of A’s partnership interest

Not authoritative, but if you Google it, you will find many 1031 exchange companies saying it's OK

You left out part of the revenue ruling:

Accordingly, A must treat the transaction as the sale of a partnership interest. Reg. § 1.741-1(b). A must report gain or loss, if any, resulting from the sale of A's partnership interest in accordance with § 741.

As far as A is concerned, it is a sale of the interest.

Excellent point. A cannot contemplate an exchange without an actual drop & swap.

Excellent point. A cannot contemplate an exchange without an actual drop & swap.

And, as pointed out, those are risky.