Are Partnership Interests Eligible for 1031 Exchanges?

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In 1984, interests in partnerships were excluded from 1031 consideration preventing Exchangors holding appreciated securities to exchange for other securities.  Fast forward, how do partners in a partnership who want to part ways sell a property?  One may want to cash out while another may want to exchange into another replacement property. 

Section 761(a) Election 

The partners can file a 761(a) along with their Form 1065 U.S. Return of Partnership Income naming all partners who elect to be wholly excluded from Subchapter K partnership rules.  This allows the partners to avoid being identified as a partnership for tax purposes.  By filing with the Internal Revenue Service on or before
the tax deadline of the year it wants to make use of the election benefits. 

Care should be given to that "in the case of a distribution by a partnership to a partner, gain is not recognized to the partner except to the extent that any money distributed exceeds the adjusted basis of the partner's interest in the partnership immediately before the distribution."   

Section 708(b)(1)(A)

This section of the Internal Revenue Code allows the partnership to terminate allowing the assets to be transferred to the partners as tenants in common.  Once title is conveyed to the partners in their respective names, the exchange can go forward with one cashing out and the deferring the gain by exchanging into a replacement property.  Or, both partners can exchange into separate properties.  Input from the partners' CPA is critical to avoid gain recognition.

It is suggested that at least one year before the sale, the partnership is terminated and assets distributed to the partners.  All partnership activity should stop and each partner file individual tax returns taking a prorated share of income and depreciation.

There are other strategies to unwind a partnership.  Contact your tax professional.