Section 1031 of the Internal Revenue Code enables taxpayers to make a tax-free exchange of real property (“relinquished property”) for other real property (“replacement property”). In order for a transaction to qualify as a tax-free like-kind exchange under Section 1031, both the relinquished property and the replacement property must be held for productive use in a trade or business or held for investment (the “holding requirement”). Partnership interests do not qualify as either relinquished property or replacement property for a 1031 exchange.

Replacement property will fail to satisfy the holding requirement if it is sold soon after it is acquired, since the holding requirement would not be satisfied. However, neither the Internal Revenue Code nor the Treasury Regulations address whether a tax-free contribution to a partnership, or a tax-free distribution by a partnership to its partners, can cause the holding requirement to not be satisfied. One common scenario where this issue comes up is when partners want to cause a partnership to acquire multiple replacement properties and then distribute separate replacement properties out to different partners that want to go their separate ways. Another common scenario is where a taxpayer wants to contribute its replacement property to a partnership shortly after a 1031 exchange. These like-kind exchanges are commonly referred to as “swap and drop” exchanges.

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