Section 1031 Drop & Swap Transactions

Posted by Todd Keator      Todd Keator recently gave a presentation addressing Section 1031 exchange “drop & swap” (and “swap & drop”) transactions.  A “drop & swap” colloquially refers to a 1031 exchange involving a partnership where the partners either complete individual 1031 exchanges at the partner level or some of the partners cash out of their investment instead of participating in the 1031 exchange with other partners.  The IRS is interested in these transactions and has a history of challenging them, with mixed success.  However, if properly structured, drop & swaps are a useful tax planning option.  The most typical structure involves distributing (i.e., the “drop”) tenancy-in-common (“TIC”) interests in the relinquished property to one or more partners prior to a future sale or exchange of the co-owned property (i.e., the “swap”).  In this structure, partners receiving the TIC interests have flexibility to sell their TIC interests as part of a 1031 exchange, or to simply cash out.  Other techniques for cashing out a partner involve use of installment notes issued by the relinquished property purchaser or, in some cases, even by the qualified intermediary facilitating the 1031 exchange.  While the TIC structure requires advance planning and can take several days or even weeks to complete, the installment note option can be implemented quickly before a closing with minimal documentation.  All of these structures and techniques require precise planning and guidance, sometimes in advance of signing a PSA for the sale of property, in order to provide the requisite level of comfort to proceed.  If you have any questions about “drop & swap” transactions or other Section 1031 exchanges, please contact Todd Keator or any of the other Tax lawyers at Thompson & Knight.