A partnership or limited liability company (LLC) cash-out 1031 exchange occurs when one or more of the partners or members want to cash-out of the investment property to be sold instead of re-investing all of the proceeds from the sale of the relinquished property into the replacement property. One popular method is a Drop and Swap.
Assuming this fact scenario, ABCD, LLC has four members, one of which wants to cash out a 25% interest and not participate in the 1031 exchange, an example of a drop and swap transaction would be one in which:
(1) ABCD, LLC would first distribute a 25% undivided interest in the relinquished property to Mr. C in liquidation of his ownership interest in ABCD, LLC, leaving the property being owned 75% by ABCD, LLC and 25% by MR. C as tenants-in-common,
(2) ABCD, LLC would sell its 75% interest in the Property and Mr. C would sell his 25% interest in the Property,
(3) Mr. C would keep his cash and pay tax on his sale transaction, and
(4) ABCD, LLC would engage in a 1031 exchange and purchase new replacement property.
Or, the same structure can be completed in a different order using a Swap and Drop. An example of a swap and drop transaction would be one in which:
(1) ABCD, LLC sells the Property and engages in a 1031 exchange by buying new replacement real property,
(2) ABCD, LLC then distributes a 25% interest in the new property to Mr. C in liquidation of his ownership interest in ABCD, LLC (resulting in the new property being owned 75% by ABCD, LLC and 25% by Mr. C as tenants-in-common), and
(3) Mr. C then sells his 25% interest in the new property, either to a third party or to the remaining members of ABCD, LLC, and pays tax on his sale transaction.
Structuring a partnership/LLC cash-out transaction is not simple or straightforward. It is important for anyone contemplating one to obtain the advice of an experienced tax professional familiar with structuring 1031 exchanges.
* Partnerships are excluded from effecting a 1031 exchange per IRC section 1031 (a)(2)(D). Consult your tax and legal counsel for more information about partnership owned property.
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