1031 Exchange Partnership Interest W/Related Party
I am selling an investment property of which I am the sole owner. I would like to purchase a 50% interest (I would get a deed for that interest) in another investment property from a related-party. The new property's cost is more than the sale price of my property. My understanding is that as long as I keep the new property for 2 years or more, a 1031 is acceptable. However, what about the 50% interest part? I have been told that I cannot exchange my existing "whole" interest for a 50% interest, because that effectively would be a partnership, which is not allowed under the 1031 guidelines. Is this correct? If so, would you be able to tell me where I could find that language in the Internal Revenue Code?
You have a number of 1031 exchange issues here, so I will try to address all of them.
Let's take your 50% interest question first. You can 1031 exchange out of a property in which you own a 100% interest in (relinquished property) and into a property in which you own a 50% interest in (replacement property), as long as both the relinquished and replacement properties are considered to be real estate interests (and not partnership interests). You are not automatically classified as a partnership just because you have acquired a 50% interest in real property. If you have set-up a formal partnership agreement, then clearly you would have a partnership issue. In some cases the Internal Revenue Service will classify you as a partnership depending on how you operate the property/business. In most cases, if you acquire a partial interest in real property as a passive investor you will not be in a partnership situation, but you should consult with your attorney to play it safe.
The related party issue is also somewhat complex. There is a two year holding period when related parties are involved that require both parties to hold title to both properties for two years. However, there is also a recent ruling from the service that indicates a related party exchange may be disallowed. It gets a little complex, but the general rule seems to be that if the related party ends up with the cash after the entire 1031 exchange transaction has been completed the transaction would be disallowed by the service. The issue that the service is concerned about is "basis swapping" which is too complex to go into here. In your example, you would purchase your replacement property from a related party. If the related party does not do a 1031 exchange from the sale of this property they would end up holding the cash and the transaction would be disallowed by the service, but would not be disallowed if the related party also did a 1031 exchange into their own replacement property.
Send me your email address and I will email a link to our web site that has all of the Internal Revenue Codes, Internal Revenue Service Regulations, Forms and Publications related to 1031 exchange transactions.
Let me know if you have any more questions.
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Bill Exeter[ Edited by wexeter on Date 07/28/2003 ]