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When can partnership interests be exchanged tax-free?

Sec. 1031 permits the exchange of "like-kind" property without the recognition of any gain realized on the exchange. However, Sec. 1031(a)(2)(D) specifically states that "interests in a partnership" are not like-kind property.

However, flush language was added to Sec. 1031(a)(2) by the Revenue Reconciliation Act of 1990, providing an exception to this general rule. An interest in a partnership with a valid Sec. 761(a) election may be treated as an interest in each of the assets of such partnership. (Sec. 761(a) permits certain partnerships to be excluded from subchapter K.) Therefore, it is possible for an exchange of a partnership interest to qualify for Sec. 1031(a) nonrecognition treatment.

Sec. 761 defines which partnerships qualify for Sec. 760(a) elections. A partnership may make the election to be excluded from all of subchapter K if the partnership is formed

-- for investment purposes only and not for the active conduct of a business (e.g., raw land joint venture),

-- for the joint production, extraction or use of property, but not for the purpose of selling services or property produced or extracted (e.g., a typical oil and gas joint venture) or,

-- by dealers in securities for a short period, for the purpose of underwriting, selling or distributing a particular issue of securities.

However, to qualify, the income of the members of the organization must be determined without the computation of partnership taxable income.

This election can be made at any time during the life of the partnership. Therefore, there is no need to establish a new partnership; an existing partnership can make this election under Sec. 761(a), and the partners can receive nonrecognition treatment under Sec. 1031(a) for the exchange of their partnership interests. This election is made by attaching a statement to a timely filed return for the year the election is desired.

Note: Regs. Sec. 1.761-2(b)(2)(ii) states that if an election was not formerly made, it will be deemed to have been made it it can be shown that the partners intended to have made the election.

From Michelle Sanders, Houston, Tex.
COPYRIGHT 1992 American Institute of CPA's
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Author:Sanders, Michelle
Publication:The Tax Adviser
Date:Feb 1, 1992
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