Interests in a Partnership
The IRS had attempted to preclude the
exchange of partnership interests by promulgating R.R. 78-135. However,
the courts consistently rejected this position (Gulfstream Land &
Dev. Crop., 71 TC 587 (1979); Arthur E. Long, 77 TC 1045
(1981); and Peter N. Pappas, 78 TC 1078 (1982)). The IRS was more
successful with Congress. The Tax Reform Act of 1984 added
partnership interests to the list of types of property specifically
excluded from exchange treatment (§1031(a)(2)(D)). The provision applies
to exchanges closed after March 31, 1984, except for exchanges under a
binding contract in effect on March 1, 1984, that remains continuously
in effect until the exchange. It appears that the prohibition on
exchanges of partnership interests does not apply to exchanges of
interests in the same partnership,
but only to exchanges of partnership interests in different partnerships
(H.R. Report. No. 98-432, 98th Cong, 2d (1984)).
Note: The exclusion of partnership
interests from §1031 causes concern for
co-tenants. While Reg. §1.761-1(a) states that the mere
property does not constitute a partnership, co-tenants may be partners
they actively carry on a trade or business. In any event, no partnership
should be filed (if necessary, an election out of partnership treatment
§761(a) should be made) and the co-tenants should individually report
pro rata shares of income and deduction. See also M.H.S. Co., TC
1976-165 for further discussion of co-tenancy versus partnership.
A §761(a) might be a good solution
for co-tenants who have previously filed
partnership tax returns. Section 761(a) permits an "unincorporated
organization" to elect out of partnership treatment provided:
(i) The organization is used for investment purposes only and not for
active conduct of a trade or business, and
(ii) The income of the members of the organization can be
determined without computation of partnership income.
exchange of interests in such an organization should be treated as an
exchange of the underlying assets.
1991 Final Regulations
The Tax Reform Act of
1984 prohibited the exchange of partnership interest. Thus,
§1031(a)(2)(D) provides that §1031(a) does not apply to any exchange of
interests in a partnership. The regulations apply this rule whether the
partnership interests exchanged are general or limited or are in the
same partnership (Reg. §1.1031(a)-1(a)(1». However, this provision does
not affect the conversion of partnership interests in the same
partnership under R.R. 84-52.
Note: House and Senate Reports to the '84 Act state that the rule
tax-free exchange treatment for partnership interests does not apply to
canes of interests in the same partnership.
The proposed regulations stated that no inference was intended with
to whether an exchange of an interest in an organization that has
elected under §761 to be excluded from the application of subchapter K
was eligible for nonrecognition of gain or loss under §1031.
Note: Section 761 allows certain
investment and operating groups to "elect out'. of subchapter K (§§701
through 761), which prescribes the manner in which partners are taxed.
Taxpayers who elect out are thus no longer subject to those rules.
According to 1984 Act "Blue Book", the rule barring tax-free exchanges
of partnership interests "is not intended to apply to organizations
which have elected, under §761(a), not to be subject to the provisions
of Subchapter K of the Code; instead, an exchange of interests in such
organizations would be treated as an Inspective and the applicability
organizations on the basis of those exchanges." In 1990, the Budget
Reconciliation Act amended §1031(a)(2) to provide that an interest in a
partnership that has in effect a valid election under §761(a ) to be
excluded from the application of all of subchapter K is treated under
§1031 as an interest in each of the assets of the partnership and not as
an interest in a partnership. The final regulations reflect this
amendment to §1031.
The amendments to §1031(a)-1 made in the final regulations with respect
exchanges of partnership interest are effective for transfers of
by taxpayers on or after April 25, 1991.
While the exchange of partnership interests is prohibited
partnership can exchange property with another partnership, individual,
entity and still be entitled to nonrecognition under §1031. However, a
frequent problem is when one or more partners want to be cashed out as
part of an exchange by the partnership. The following methods of
effecting such a division may be tried, but it is unclear whether the
Service or the courts will uphold them: 9-11
Historically, the Service has
required the taxpayer to hold both the property put
into the exchange and the property taken out of the exchange for the
qualified purposes (R.R. 75-291; R.R. 75-292 & R.R. 77-337). Implicit in
is that the taxpayer must go in and out of the exchange as the same
entity. However, some cases have challenged this position!
Traditionally, a taxpayer could not go into the exchange as individual
and come out as a corporation, partnership, trust, estate or other
separate entity. Until recently there has been no "Doctor Jekyll -
Mister Hyde" corollary under §1031. You could not go into the
exchange transaction as a cater-pillar and exit a butterfly .
For more information on this matter or if we
may be of further assistance please contact us for a free consultation
by calling us at 1 (800) 781-1031
or (714) 939-1031 or
by e-mail at
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