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Options exist when partners can't agree on exchange.

Like-kind exchanges enable real estate investors to exchange real property for other real estate and defer tax on the gain. What happens, though, if a partnership decides to do an exchange but at least one partner wants cash, not the new property?

The US tax code enables a partnership to do a like-kind exchange (Section 1031), while allowing a partner to receive cash and end his investment in the property through an election under Section 761 (a).

Doing a like-kind exchange as defined in Section 1031 requires several important steps to make sure that real estate investors can defer the capital gains tax. The tax law allows real estate held for investment or used in a trade or business to be exchanged for other real estate. Unimproved land can be exchanged for improved land and vice versa.

A critical first move for a partnership or any other real estate investor considering such an exchange is to identify a qualified intermediary. Like-kind exchanges require a professional--you typically can't just go out and ask someone selling a property to trade. The intermediary is really the middle man or clearinghouse for like-kind exchanges. This individual identifies properties that can be exchanged. In most cases, the deal is not simply arranging to exchange one property directly for another. The deal involves multiple properties. For example, a cash buyer may purchase a property owned by a partnership interested in a like-kind exchange. That partnership sells the property to the cash buyer, but uses that money to acquire another property through an exchange performed by the intermediary. That enables the partnership to own a new property and defer capital gains.

Conducting like-kind exchanges requires adherence to the timeline outlined in the tax code. A replacement property must be identified within 45 days of the sale or purchase. The sale or purchase must be complete within 180 days.

After understanding the basics of like-kind exchanges, one can begin addressing how to allow one partner to sell his interest for cash, while the other retains its interest in the exchanged property. Both the partner who wants to defer gains and the partner who wants cash can achieve their goals through an election under 7RC Section 761(a). In this case, the partnership opts to become tenants in common, rather than a partnership solely for the purpose of the property sale/exchange. All tenants must agree that this new relationship is not a partnership.

By creating a tenants-in-common relationship, each partner (now tenant in this particular relationship) has the individual right to do with his interest what he wants--whether to sell his stake or exchange it. The tenants in common who want to do a like-kind exchange must combine their interests to "purchase" the new property.

The tenant in common who wants the cash has a couple of options. The individual could sell his share of the property directly to the buyer. In this case, the original partnership remains intact--though their individual property interests have changed with the application of the tenants-in-common arrangement.

Another option is that the partner or tenant in common who wants cash can have his interest purchased by the other partners or tenants in common prior to the like-kind property exchange. In this example, the partners who want to do the exchange option would give a note to the cash-option partner. After the exchange partners have found a new property through the intermediary, they can immediately refinance it so they can pay off the note to the cash-option partner.

Thereby, each partner receives what he wants.
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Title Annotation:Insiders Outlook; real estate investors
Author:Wieder, Marc
Publication:Real Estate Weekly
Geographic Code:1USA
Date:Nov 10, 2004
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