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GITDEC | Partnership exchanges IRC §1.761-2(a) |
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Q and A: FAQ's Glossary 1031 Exchange Basics: How and Why 1031: 1031 Documents: Samples: Corporate Information: Ask us about 1031 Company Information Webmaster |
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The Tax Reform Act of 1984 made it very clear that partnership interests cannot be
exchanged and qualify for deferred gain treatment under Internal Revenue Code (IRC) §1031. The regulations also interpret no difference between general partnership interests or limited partnership
interests. Although actual partnerships can exchange with other partnerships under §1031, the exchange of an individual interest is prohibited.
However, the Omnibus Budget Reconciliation Act of 1990 amended IRC §1031 to incorporate the use of IRC §1.761-2(a), Election of Partnerships, to not be treated under Subchapter K of Chapter 1 of the Code, for the purposes of taxation. This means that §1.761-2(a) can potentially provide an avenue to utilize §1031 to those investors currently owning partnership interests. How does an election under §1.761-2(a) provide a benefit to the typical investor? If every individual or entity within a partnership elects to have his individual interest treated as his or her own real property interest, similar to a tenant in common interest, then that individual interest can qualify to be exchanged under §1031. And since that partnership interest can qualify for deferred gain treatment, the amount realized from the sale of that interest, can be used to acquire any qualifying replacement property. Therefore, an interest from a partnership in which all partners have made individual elections under §1.761-2(a) can be exchanged for any other property. There is no requirement that the investor exchange into replacement properties with his or her previous partners; the exchange must be used for investment purposes only and not for the active conduct of a business. The converse of the above §1.761-2(a) situation is possible. It is permissible for a partnership to acquire a property and elect to have the partnership interests treated as individual real property interests for taxation purposes, at the time of purchase. Therefore, as seen in some sophisticated transactions, particular partnerships which have already ready elected under §1.761-2(a), may be established for the sole purpose to solicit investments from other partners exchanging out of one partnership (with the benefit of §1.761-2(a)) into the new entity. This process enables the investor to exchange out of one previously unexchangeable investment, into one which provides little or no management and superior cash flow or other benefits. This above strategy can also be used for business assets. In both cases however, it is important to outline the goals and objectives of all parties involved in the exchange. It should be noted that in every case involving an election under §1.761-2(a), it is critical to evaluate the status of your election and exchange with the advice of a qualified tax professional. If necessary, contact your accountant and be sure to read the entire section of §1.761-2(a) and its accompanying commentaries. They will relate to specific Internal Revenue Letter Rulings and other interpretations which could assist in the strategic structuring of your transaction. |
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