Category: 1031 Exchange General

One requirement of tax-deferred exchanges of property has always been that the property acquired, the Replacement Property, be of a “like-kind” to the property sold, the Relinquished Property, even as far back as 1921 when IRC Section 1031 was added to the tax code. The basis for this requirement is the “continuity of investment” doctrine, which reasons that where a taxpayer is merely continuing its investment from one property into a similar kind of property without receiving any cash profit from the sale, no tax should be triggered. Of course, this tax liability is only deferred, not eliminated. So, given that it is such an essential element of any tax-deferred exchange, what exactly does “like-kind” mean?
Fortunately, in the context of real property, the analysis is simple. For 1031 exchange purposes, all real property is generally “like-kind” to all other real property, and, despite many misconceptions out there about the nature of this requirement, the asset class or specific type of property is irrelevant. In other words, if a taxpayer is selling an apartment building, she does not have to acquire another apartment building. Rather, she can acquire any other type of real estate as replacement property, like raw land, an office building, an interest in a Delaware Statutory Trust, etc., provided that the replacement property is considered real property under applicable rules and that she intends to hold it for a qualified purpose, i.e.business or investment use, and properly identified within the 45-day identification period. (Note: the “like-kind” analysis was not always so simple in the personal property context (i.e. anything that isn’t real property), but in 2018 the Tax Cuts and Jobs Act amended the law and personal property exchanges are no longer eligible for tax deferral under Section 1031).
This begs the obvious question: what is “real property” for purposes of Section 1031?
Examples of Real Estate Interests that are Like-Kind
Most real property consists of a piece of land with or without a structure on it. It doesn’t matter what type of structure, they are all like-kind. Even vacant land can be held for rental or simply held for appreciation. Real estate does not have to be rental in nature to qualify. There are also many other types of real estate interests that might not readily come to mind but are considered like-kind to any other real property interest. Below is a list of some of them:

Single or multi-family rental properties
Office buildings
Apartment buildings
Shopping centers
Warehouses
Industrial property
Farm and ranch land
Vacant land held for appreciation in value
Cooperative apartments (Co-ops)
Delaware Statutory Trusts (DSTs)
Hotels and motels
Cell tower and billboard easements
Conservation easements
Lessee’s interest in a 30-year lease (NOT a lessor’s interest)
Warehouses
Interests in a Contract for Deed
Land trusts
Growing crops
Mineral, oil, and gas rights
Water and timber rights
Wind farms
Solar arrays

Inclusion of other types of property as Real Property
In December 2020, the IRS issued new regulations that further defined real property in the Code of Federal Regulations. It did not change the fact that all real estate is like-kind to all other real estate. Rather, it provided additional clarification as to certain types of “inherently permanent structures” and “structural components” of those inherently permanent structures are considered part of the real estate, and thus eligible for exchange treatment.
By way of example, some “inherently permanent structures” that are considered real property and thus exchangeable are:
Other inherently permanent structures. Inherently permanent structures under paragraph (a)(2)(ii) of this section include the following distinct assets, if permanently affixed: In-ground swimming pools; roads; bridges; tunnels; paved parking areas, parking facilities, and other pavements; special foundations; stationary wharves and docks; fences; inherently permanent advertising displays for which an election under section 1033(g)(3) is in effect; inherently permanent outdoor lighting facilities; railroad tracks and signals; telephone poles; power generation and transmission facilities; permanently installed telecommunications cables; microwave transmission, cell, broadcasting, and electric transmission towers; oil and gas pipelines; offshore platforms, derricks, oil and gas storage tanks; and grain storage bins and silos . . . . See 26 CFR §1.1031(a)-3(a)(2)(ii)(C).
As for “structural components” that are likely to qualify as real property, the following examples appear in the regulations:
Walls; partitions; doors; wiring; plumbing systems; central air conditioning and heating systems; pipes and ducts; elevators and escalators; floors; ceilings; permanent coverings of walls, floors, and ceilings; insulation; chimneys; fire suppression systems, including sprinkler systems and fire alarms; fire escapes; security systems; humidity control systems; and other similar property . . . . See 26 CFR §1.1031(a)-3(a)(2)(iii)(B)
There is a lot more detail in these regulations and although this may seem like a lot of minutiae, but these assets, where present, can sometimes have a significant effect on transaction value which can also be included as part of the real estate for §1031 exchange purposes. In any event, taxpayers now have the benefit of additional IRS guidance that clarifies the components of real property, or other interests related to real property, that qualify for exchange treatment.
Foreign Real Estate Is Not Considered Like-Kind
Section 1031(h) of the Tax Code provides that real estate located within the United States and real estate located outside of the United States are not considered like-kind. With some limited exceptions, most U.S. territories are not considered property in the U.S. United States taxpayers who wish to trade foreign property for foreign property may do so and it is considered like-kind and can receive §1031 exchange treatment.
For all exchanges, in addition to meeting the like-kind requirements above, potential replacement property needs to be formally identified within 45 days of the sale of relinquished property and an identified property has to be acquired within 180 days of the sale. As referenced above, Section 1031(a) provides that property received by a taxpayer that was not identified or received within these timeframes is not considered like-kind.
Many people, and in some cases, even professional advisers, think that the like-kind requirement means that the taxpayer must trade into the same kind of property she has sold. Since the basis for Section 1031 tax deferral has always been continuity of investment, a consequence of that concept is that the properties had to be the same nature or character, i.e., like-kind. During most of the period when Section 1031 has been part of the Tax Code, exchanges could be done for assets including personal property, intangible property, and real estate. All those asset types were subject to the like-kind requirement and like-kind meant something different for each of them.
As of 2018, only real estate can be exchanged under Section 1031, and essentially the determination of what kind of real estate was like-kind to other type of real estate has been unchanged. All real estate is like-kind to other types of real estate.

Exchangers often ask whether they can start a 1031 exchange by selling an investment property, and then sell a second investment property as part of that same exchange, after the 45-day identification period closes. The short answer is yes.
The typical 1031 Exchange transaction involves selling one property, identifying potential replacement properties within the 45-day Identification Period, and then acquiring one or more of those identified properties within the 180-day Exchange Period. The 1031 Exchange regulations provide that, “If, as part of the same deferred exchange, the taxpayer transfers more than one relinquished property and the relinquished properties are transferred on different dates, the identification period and the exchange period are determined with reference to the earliest date on which any of the properties are transferred.”
Consider the following 1031 Exchange scenario:

Exchanger transfers Relinquished Property A on June 1, 2023
The 45-day Identification Period ends on July 16, 2023
The 180-day Exchange Period ends on November 28, 2023
On July 16, Exchanger properly identifies Property Z as Replacement Property
On August 1, 2023 Exchanger disposes of additional investment property, Property B, as another Relinquished Property within the same exchange
Exchanger acquires the identified Replacement Property, Property Z, on September 1, 2023

The above scenario is entirely permissible, since Exchanger has transferred both of the Relinquished Properties before acquiring the Replacement Property.
Similarly, Exchanger could have identified Properties X, Y & Z during the Identification Period, and thereafter acquired Properties Y & Z, provided both acquisitions were completed within the 180-day Exchange Period. 
In the above scenario, Exchanger should be aware of the following considerations to ensure for full tax deferral: 

Property Z is worth equal or more than the combined value of Properties A & B
All of the exchange cash generated by the dispositions of Properties A & B are applied toward the acquisition of Property Z
Any debt retired upon the transfer of Properties A & B was replaced with new debt or new cash in the acquisition of Property Z

Exchangers often ask whether they can start a 1031 exchange by selling an investment property, and then sell a second investment property as part of that same exchange, after the 45-day identification period closes. The short answer is yes.
The typical 1031 Exchange transaction involves selling one property, identifying potential replacement properties within the 45-day Identification Period, and then acquiring one or more of those identified properties within the 180-day Exchange Period. The 1031 Exchange regulations provide that, “If, as part of the same deferred exchange, the taxpayer transfers more than one relinquished property and the relinquished properties are transferred on different dates, the identification period and the exchange period are determined with reference to the earliest date on which any of the properties are transferred.”
Consider the following 1031 Exchange scenario:

Exchanger transfers Relinquished Property A on June 1, 2023
The 45-day Identification Period ends on July 16, 2023
The 180-day Exchange Period ends on November 28, 2023
On July 16, Exchanger properly identifies Property Z as Replacement Property
On August 1, 2023 Exchanger disposes of additional investment property, Property B, as another Relinquished Property within the same exchange
Exchanger acquires the identified Replacement Property, Property Z, on September 1, 2023

The above scenario is entirely permissible, since Exchanger has transferred both of the Relinquished Properties before acquiring the Replacement Property.
Similarly, Exchanger could have identified Properties X, Y & Z during the Identification Period, and thereafter acquired Properties Y & Z, provided both acquisitions were completed within the 180-day Exchange Period. 
In the above scenario, Exchanger should be aware of the following considerations to ensure for full tax deferral: 

Property Z is worth equal or more than the combined value of Properties A & B
All of the exchange cash generated by the dispositions of Properties A & B are applied toward the acquisition of Property Z
Any debt retired upon the transfer of Properties A & B was replaced with new debt or new cash in the acquisition of Property Z

Exchangers often ask whether they can start a 1031 exchange by selling an investment property, and then sell a second investment property as part of that same exchange, after the 45-day identification period closes. The short answer is yes.
The typical 1031 Exchange transaction involves selling one property, identifying potential replacement properties within the 45-day Identification Period, and then acquiring one or more of those identified properties within the 180-day Exchange Period. The 1031 Exchange regulations provide that, “If, as part of the same deferred exchange, the taxpayer transfers more than one relinquished property and the relinquished properties are transferred on different dates, the identification period and the exchange period are determined with reference to the earliest date on which any of the properties are transferred.”
Consider the following 1031 Exchange scenario:

Exchanger transfers Relinquished Property A on June 1, 2023
The 45-day Identification Period ends on July 16, 2023
The 180-day Exchange Period ends on November 28, 2023
On July 16, Exchanger properly identifies Property Z as Replacement Property
On August 1, 2023 Exchanger disposes of additional investment property, Property B, as another Relinquished Property within the same exchange
Exchanger acquires the identified Replacement Property, Property Z, on September 1, 2023

The above scenario is entirely permissible, since Exchanger has transferred both of the Relinquished Properties before acquiring the Replacement Property.
Similarly, Exchanger could have identified Properties X, Y & Z during the Identification Period, and thereafter acquired Properties Y & Z, provided both acquisitions were completed within the 180-day Exchange Period. 
In the above scenario, Exchanger should be aware of the following considerations to ensure for full tax deferral: 

Property Z is worth equal or more than the combined value of Properties A & B
All of the exchange cash generated by the dispositions of Properties A & B are applied toward the acquisition of Property Z
Any debt retired upon the transfer of Properties A & B was replaced with new debt or new cash in the acquisition of Property Z

We continue to receive inquiries about potential real estate transactions involving federal and state grazing permits and leases and other special use permits that may involve the U.S. Forest Service (U.S. Department of Agriculture), Bureau of Land Management (Department of the Interior) and various state agencies, to name a few.
The typical situation arises when an Exchanger has sold a ranch or farm property along with Federal or State grazing permits and/or leases and the transfer of the permits and/or leases was included as part of the entire real property exchange transaction. Prior to December 2020, the conventional wisdom was that those Federal permits could be viewed as similar to long-term leases of 30+ years, which are viewed by the IRS as “like-kind” to fee ownership interests in real property and therefore qualified as part of the overall real property transaction. Typically, the Federal permits are issued for a term of from 10 to 12 years with provisions allowing for renewal as long as the permittee is in good standing with the agency. Many of those permits may have been held by the permittees for 50 years or more. However, there was no clear consensus on whether that interpretation would be upheld.
New 1031 regulations were issued in December 2020 by the IRS and Treasury that clarified which types of intangible real property interests might qualify as “like kind” real property for purposes of effecting a 1031 exchange and tax deferral on the transaction. Specifically, the new regs at § 1.1031(a)-3 state that “Under paragraph (a)(5) of this section, an intangible interest in real property of a type described in this paragraph (a)(1) is real property for purposes of section 1031 and this section.” The referenced paragraph (a)(5) goes on to state that interests such as leaseholds, options to acquire real property, easements, and stock in a cooperative housing corporation qualify as 1031 real property interests. The paragraph goes on to provide as follows: “Similar interests are real property for purposes of section 1031 and this section if the intangible asset derives its value from real property or an interest in real property and is inseparable from that real property or interest in real property.”
In a subsequent subparagraph, paragraph (a)(5), the IRS further clarifies “(ii) Licenses and permits. A license, permit, or other similar right that is solely for the use, enjoyment, or occupation of land … and that is in the nature of a leasehold, easement, or other similar right, generally is an interest in real property under this section.” The IRS then cites some examples, one of which is similar to grazing permits and reads as follows:
“Example 11: Land use permit. K receives a special use permit from the government to place a cell tower on Federal Government land that abuts a federal highway. Government regulations provide that the permit is not a lease of the land, but is a permit to use the land for a cell tower. Under the permit, the government reserves the right to cancel the permit and compensate K if the site is needed for a higher public purpose. The permit is in the nature of a leasehold that allows K to place a cell tower in a specific location on government land. Therefore, the permit is an interest in real property under paragraph (a)(5) of this section. (Note: highlighted portions added by the author)
Based upon the foregoing information, a strong argument can be made that any value attributable to permits that are part of a much larger land transaction as referenced above qualifies for 1031 tax deferral so long as the Exchanger uses the funds within the 1031 exchange timeline to acquire qualifying replacement property.
Depending on the type of grazing or other special use permits at play, some additional information may be required to fully assess the situation, which could include any of the following:

Allotment names and identifying numbers
USFS Ranger District info for the allotments
BLM District Office info for the allotments
Name of Exchanger entity or entities that are the listed permittee(s)

We are aware of fairly recent variations on the more common scenario outlined above where a conservation or environmental entity will pay a landowner/Federal permittee a sum of money to waive or assign some, or all, of their grazing permits or other special use permits, back to the Federal agencies that issued the permits. The apparent goal of the payor entity is to encourage the Federal permittees to cease grazing their livestock on public lands and return the public lands to a more “natural” state. This enticement may make sense if the permittee can use the proceeds from the transaction to acquire other grazing lands and defer the taxable event by using 1031 exchange.
A couple of factors that make this scenario unique to the more common one discussed above include the following:

The Exchanger will not be selling commensurate base property or permitted livestock to effect the permit waivers or transfers in question.
The Exchanger will also not be conveying the permits to the Buyer as a new permittee. Rather the permits simply revert to the respective agencies.

Whether this type of transaction has any merit from a conservation standpoint or complies with the various Federal laws allowing for livestock grazing on public lands is open for debate. However, it appears that the taxpayer/permittee in such a situation can probably parlay the monetary consideration they receive into a valid 1031 exchange.

We continue to receive inquiries about potential real estate transactions involving federal and state grazing permits and leases and other special use permits that may involve the U.S. Forest Service (U.S. Department of Agriculture), Bureau of Land Management (Department of the Interior) and various state agencies, to name a few.
The typical situation arises when an Exchanger has sold a ranch or farm property along with Federal or State grazing permits and/or leases and the transfer of the permits and/or leases was included as part of the entire real property exchange transaction. Prior to December 2020, the conventional wisdom was that those Federal permits could be viewed as similar to long-term leases of 30+ years, which are viewed by the IRS as “like-kind” to fee ownership interests in real property and therefore qualified as part of the overall real property transaction. Typically, the Federal permits are issued for a term of from 10 to 12 years with provisions allowing for renewal as long as the permittee is in good standing with the agency. Many of those permits may have been held by the permittees for 50 years or more. However, there was no clear consensus on whether that interpretation would be upheld.
New 1031 regulations were issued in December 2020 by the IRS and Treasury that clarified which types of intangible real property interests might qualify as “like kind” real property for purposes of effecting a 1031 exchange and tax deferral on the transaction. Specifically, the new regs at § 1.1031(a)-3 state that “Under paragraph (a)(5) of this section, an intangible interest in real property of a type described in this paragraph (a)(1) is real property for purposes of section 1031 and this section.” The referenced paragraph (a)(5) goes on to state that interests such as leaseholds, options to acquire real property, easements, and stock in a cooperative housing corporation qualify as 1031 real property interests. The paragraph goes on to provide as follows: “Similar interests are real property for purposes of section 1031 and this section if the intangible asset derives its value from real property or an interest in real property and is inseparable from that real property or interest in real property.”
In a subsequent subparagraph, paragraph (a)(5), the IRS further clarifies “(ii) Licenses and permits. A license, permit, or other similar right that is solely for the use, enjoyment, or occupation of land … and that is in the nature of a leasehold, easement, or other similar right, generally is an interest in real property under this section.” The IRS then cites some examples, one of which is similar to grazing permits and reads as follows:
“Example 11: Land use permit. K receives a special use permit from the government to place a cell tower on Federal Government land that abuts a federal highway. Government regulations provide that the permit is not a lease of the land, but is a permit to use the land for a cell tower. Under the permit, the government reserves the right to cancel the permit and compensate K if the site is needed for a higher public purpose. The permit is in the nature of a leasehold that allows K to place a cell tower in a specific location on government land. Therefore, the permit is an interest in real property under paragraph (a)(5) of this section. (Note: highlighted portions added by the author)
Based upon the foregoing information, a strong argument can be made that any value attributable to permits that are part of a much larger land transaction as referenced above qualifies for 1031 tax deferral so long as the Exchanger uses the funds within the 1031 exchange timeline to acquire qualifying replacement property.
Depending on the type of grazing or other special use permits at play, some additional information may be required to fully assess the situation, which could include any of the following:

Allotment names and identifying numbers
USFS Ranger District info for the allotments
BLM District Office info for the allotments
Name of Exchanger entity or entities that are the listed permittee(s)

We are aware of fairly recent variations on the more common scenario outlined above where a conservation or environmental entity will pay a landowner/Federal permittee a sum of money to waive or assign some, or all, of their grazing permits or other special use permits, back to the Federal agencies that issued the permits. The apparent goal of the payor entity is to encourage the Federal permittees to cease grazing their livestock on public lands and return the public lands to a more “natural” state. This enticement may make sense if the permittee can use the proceeds from the transaction to acquire other grazing lands and defer the taxable event by using 1031 exchange.
A couple of factors that make this scenario unique to the more common one discussed above include the following:

The Exchanger will not be selling commensurate base property or permitted livestock to effect the permit waivers or transfers in question.
The Exchanger will also not be conveying the permits to the Buyer as a new permittee. Rather the permits simply revert to the respective agencies.

Whether this type of transaction has any merit from a conservation standpoint or complies with the various Federal laws allowing for livestock grazing on public lands is open for debate. However, it appears that the taxpayer/permittee in such a situation can probably parlay the monetary consideration they receive into a valid 1031 exchange.

We continue to receive inquiries about potential real estate transactions involving federal and state grazing permits and leases and other special use permits that may involve the U.S. Forest Service (U.S. Department of Agriculture), Bureau of Land Management (Department of the Interior) and various state agencies, to name a few.
The typical situation arises when an Exchanger has sold a ranch or farm property along with Federal or State grazing permits and/or leases and the transfer of the permits and/or leases was included as part of the entire real property exchange transaction. Prior to December 2020, the conventional wisdom was that those Federal permits could be viewed as similar to long-term leases of 30+ years, which are viewed by the IRS as “like-kind” to fee ownership interests in real property and therefore qualified as part of the overall real property transaction. Typically, the Federal permits are issued for a term of from 10 to 12 years with provisions allowing for renewal as long as the permittee is in good standing with the agency. Many of those permits may have been held by the permittees for 50 years or more. However, there was no clear consensus on whether that interpretation would be upheld.
New 1031 regulations were issued in December 2020 by the IRS and Treasury that clarified which types of intangible real property interests might qualify as “like kind” real property for purposes of effecting a 1031 exchange and tax deferral on the transaction. Specifically, the new regs at § 1.1031(a)-3 state that “Under paragraph (a)(5) of this section, an intangible interest in real property of a type described in this paragraph (a)(1) is real property for purposes of section 1031 and this section.” The referenced paragraph (a)(5) goes on to state that interests such as leaseholds, options to acquire real property, easements, and stock in a cooperative housing corporation qualify as 1031 real property interests. The paragraph goes on to provide as follows: “Similar interests are real property for purposes of section 1031 and this section if the intangible asset derives its value from real property or an interest in real property and is inseparable from that real property or interest in real property.”
In a subsequent subparagraph, paragraph (a)(5), the IRS further clarifies “(ii) Licenses and permits. A license, permit, or other similar right that is solely for the use, enjoyment, or occupation of land … and that is in the nature of a leasehold, easement, or other similar right, generally is an interest in real property under this section.” The IRS then cites some examples, one of which is similar to grazing permits and reads as follows:
“Example 11: Land use permit. K receives a special use permit from the government to place a cell tower on Federal Government land that abuts a federal highway. Government regulations provide that the permit is not a lease of the land, but is a permit to use the land for a cell tower. Under the permit, the government reserves the right to cancel the permit and compensate K if the site is needed for a higher public purpose. The permit is in the nature of a leasehold that allows K to place a cell tower in a specific location on government land. Therefore, the permit is an interest in real property under paragraph (a)(5) of this section. (Note: highlighted portions added by the author)
Based upon the foregoing information, a strong argument can be made that any value attributable to permits that are part of a much larger land transaction as referenced above qualifies for 1031 tax deferral so long as the Exchanger uses the funds within the 1031 exchange timeline to acquire qualifying replacement property.
Depending on the type of grazing or other special use permits at play, some additional information may be required to fully assess the situation, which could include any of the following:

Allotment names and identifying numbers
USFS Ranger District info for the allotments
BLM District Office info for the allotments
Name of Exchanger entity or entities that are the listed permittee(s)

We are aware of fairly recent variations on the more common scenario outlined above where a conservation or environmental entity will pay a landowner/Federal permittee a sum of money to waive or assign some, or all, of their grazing permits or other special use permits, back to the Federal agencies that issued the permits. The apparent goal of the payor entity is to encourage the Federal permittees to cease grazing their livestock on public lands and return the public lands to a more “natural” state. This enticement may make sense if the permittee can use the proceeds from the transaction to acquire other grazing lands and defer the taxable event by using 1031 exchange.
A couple of factors that make this scenario unique to the more common one discussed above include the following:

The Exchanger will not be selling commensurate base property or permitted livestock to effect the permit waivers or transfers in question.
The Exchanger will also not be conveying the permits to the Buyer as a new permittee. Rather the permits simply revert to the respective agencies.

Whether this type of transaction has any merit from a conservation standpoint or complies with the various Federal laws allowing for livestock grazing on public lands is open for debate. However, it appears that the taxpayer/permittee in such a situation can probably parlay the monetary consideration they receive into a valid 1031 exchange.

Much has been written about the Same Taxpayer rule and about Drop and Swap transactions. But what happens when one of the partners wishes to cash out upon sale and the other wishes to continue investing?
The Situation
Ross and Joey have been friends their entire lives. After college they decided to pool some cash and buy investment real estate. Rather than consulting an attorney or CPA, they bought books, attended seminars, and talked to friends about their plans. As a result, they went online and formed Unagi LLC, and a short time later acquired their first rental property – a duplex in Bethlehem, PA – for $310,000. During the thirty years that they owned the property, it has been well maintained, and has generated significant cash flow for the friends. Joey has decided that he no longer wants to own this property, he wants to enjoy the use of his share of the sale proceeds and retire to Southern California; however, Ross wants to continue investing in real estate. Their friend, Gunther, is a real estate agent, and has told them that they can sell the property for about $1,600,000.
The Problem
Ross recognizes that the sale of the property would result in capital gains tax on $1,290,000 ($1,600,000 minus $310,000), plus depreciation recapture tax on $310,000. Their tax on the gain would be about $258,000, plus an additional $85,000 in depreciation recapture tax, plus state taxes (3.07% tax rate of PA) of roughly $39,603, and net investment income tax of $49,020 at a rate of 3.8%. Their $1,290,000 profit would be reduced by at least $431,623 due to associated taxes. Ross isn’t willing to incur this taxable event.
The Solution
Ross and Joey consult their tax and legal advisors, and structure a variation of the “drop and swap” strategy in that Joey will withdraw from the LLC under state laws. In exchange for his 50% interest in Unagi LLC, he will become a 50% tenant in common owner of the property, owning alongside Unagi LLC. Simultaneous with Joey’s withdrawal from the LLC, Ross’s sister Monica will become a 1% member of Unagi LLC, allowing its status as a tax partnership to remain intact because Unagi LLC continues to have multiple members, notwithstanding the change of members. At the end of the year, Unagi LLC’s CPA will issue appropriate documents so that Joey will recognize his fair share of the depreciation recapture and capital gains. The result to Joey should effectively be no different than it would have been if he stayed in the LLC and the property was simply sold without an exchange.
At the time of the sale of the Bethlehem duplex, Joey will receive his 50% share of the proceeds in a taxable event to him. Ross has consulted with additional tax and legal advisors, and Unagi LLC will enlist the aid of a Qualified Intermediary (“QI”) such as Accruit to help structure its portion of the transaction as a 1031 exchange, allowing him to defer the associated taxes. The QI will work with the other professionals involved in the transaction, preparing the necessary exchange documents, and holding Unagi’s share of the sale proceeds. Within 45 days after the sale, Unagi LLC will identify appropriate replacement properties. Learn more about the Rules for Identification and Receipt of Replacement Property in a 1031 exchange. Using the exchange proceeds held by the QI, Unagi will complete the acquisition of a new property, Replacement Property, worth at least $800,000, thereby exchanging equal or up, and maximizing the value of their 1031 exchange.
The Result
Joey was able to cash out of the original investment property, pay associated taxes, and retire to Southern California, where he is now pursuing an acting career. Ross and Monica, as the two members of Unagi LLC, continue to own investment property in the Bethlehem area. Ross deferred the taxes from the sale of the original investment property by utilizing a 1031 Exchange. Those taxes will remain deferred until Ross completes a real estate transaction, if ever, without the use of a 1031 Exchange.
As always, taxpayers are encouraged to discuss their plans with their tax and legal advisors before they embark on the path toward the sale of an investment or business use property, and to engage the services of a Qualified Intermediary the first closing that will be part of their exchange.

Much has been written about the Same Taxpayer rule and about Drop and Swap transactions. But what happens when one of the partners wishes to cash out upon sale and the other wishes to continue investing?
The Situation
Ross and Joey have been friends their entire lives. After college they decided to pool some cash and buy investment real estate. Rather than consulting an attorney or CPA, they bought books, attended seminars, and talked to friends about their plans. As a result, they went online and formed Unagi LLC, and a short time later acquired their first rental property – a duplex in Bethlehem, PA – for $310,000. During the thirty years that they owned the property, it has been well maintained, and has generated significant cash flow for the friends. Joey has decided that he no longer wants to own this property, he wants to enjoy the use of his share of the sale proceeds and retire to Southern California; however, Ross wants to continue investing in real estate. Their friend, Gunther, is a real estate agent, and has told them that they can sell the property for about $1,600,000.
The Problem
Ross recognizes that the sale of the property would result in capital gains tax on $1,290,000 ($1,600,000 minus $310,000), plus depreciation recapture tax on $310,000. Their tax on the gain would be about $258,000, plus an additional $85,000 in depreciation recapture tax, plus state taxes (3.07% tax rate of PA) of roughly $39,603, and net investment income tax of $49,020 at a rate of 3.8%. Their $1,290,000 profit would be reduced by at least $431,623 due to associated taxes. Ross isn’t willing to incur this taxable event.
The Solution
Ross and Joey consult their tax and legal advisors, and structure a variation of the “drop and swap” strategy in that Joey will withdraw from the LLC under state laws. In exchange for his 50% interest in Unagi LLC, he will become a 50% tenant in common owner of the property, owning alongside Unagi LLC. Simultaneous with Joey’s withdrawal from the LLC, Ross’s sister Monica will become a 1% member of Unagi LLC, allowing its status as a tax partnership to remain intact because Unagi LLC continues to have multiple members, notwithstanding the change of members. At the end of the year, Unagi LLC’s CPA will issue appropriate documents so that Joey will recognize his fair share of the depreciation recapture and capital gains. The result to Joey should effectively be no different than it would have been if he stayed in the LLC and the property was simply sold without an exchange.
At the time of the sale of the Bethlehem duplex, Joey will receive his 50% share of the proceeds in a taxable event to him. Ross has consulted with additional tax and legal advisors, and Unagi LLC will enlist the aid of a Qualified Intermediary (“QI”) such as Accruit to help structure its portion of the transaction as a 1031 exchange, allowing him to defer the associated taxes. The QI will work with the other professionals involved in the transaction, preparing the necessary exchange documents, and holding Unagi’s share of the sale proceeds. Within 45 days after the sale, Unagi LLC will identify appropriate replacement properties. Learn more about the Rules for Identification and Receipt of Replacement Property in a 1031 exchange. Using the exchange proceeds held by the QI, Unagi will complete the acquisition of a new property, Replacement Property, worth at least $800,000, thereby exchanging equal or up, and maximizing the value of their 1031 exchange.
The Result
Joey was able to cash out of the original investment property, pay associated taxes, and retire to Southern California, where he is now pursuing an acting career. Ross and Monica, as the two members of Unagi LLC, continue to own investment property in the Bethlehem area. Ross deferred the taxes from the sale of the original investment property by utilizing a 1031 Exchange. Those taxes will remain deferred until Ross completes a real estate transaction, if ever, without the use of a 1031 Exchange.
As always, taxpayers are encouraged to discuss their plans with their tax and legal advisors before they embark on the path toward the sale of an investment or business use property, and to engage the services of a Qualified Intermediary the first closing that will be part of their exchange.

Much has been written about the Same Taxpayer rule and about Drop and Swap transactions. But what happens when one of the partners wishes to cash out upon sale and the other wishes to continue investing?
The Situation
Ross and Joey have been friends their entire lives. After college they decided to pool some cash and buy investment real estate. Rather than consulting an attorney or CPA, they bought books, attended seminars, and talked to friends about their plans. As a result, they went online and formed Unagi LLC, and a short time later acquired their first rental property – a duplex in Bethlehem, PA – for $310,000. During the thirty years that they owned the property, it has been well maintained, and has generated significant cash flow for the friends. Joey has decided that he no longer wants to own this property, he wants to enjoy the use of his share of the sale proceeds and retire to Southern California; however, Ross wants to continue investing in real estate. Their friend, Gunther, is a real estate agent, and has told them that they can sell the property for about $1,600,000.
The Problem
Ross recognizes that the sale of the property would result in capital gains tax on $1,290,000 ($1,600,000 minus $310,000), plus depreciation recapture tax on $310,000. Their tax on the gain would be about $258,000, plus an additional $85,000 in depreciation recapture tax, plus state taxes (3.07% tax rate of PA) of roughly $39,603, and net investment income tax of $49,020 at a rate of 3.8%. Their $1,290,000 profit would be reduced by at least $431,623 due to associated taxes. Ross isn’t willing to incur this taxable event.
The Solution
Ross and Joey consult their tax and legal advisors, and structure a variation of the “drop and swap” strategy in that Joey will withdraw from the LLC under state laws. In exchange for his 50% interest in Unagi LLC, he will become a 50% tenant in common owner of the property, owning alongside Unagi LLC. Simultaneous with Joey’s withdrawal from the LLC, Ross’s sister Monica will become a 1% member of Unagi LLC, allowing its status as a tax partnership to remain intact because Unagi LLC continues to have multiple members, notwithstanding the change of members. At the end of the year, Unagi LLC’s CPA will issue appropriate documents so that Joey will recognize his fair share of the depreciation recapture and capital gains. The result to Joey should effectively be no different than it would have been if he stayed in the LLC and the property was simply sold without an exchange.
At the time of the sale of the Bethlehem duplex, Joey will receive his 50% share of the proceeds in a taxable event to him. Ross has consulted with additional tax and legal advisors, and Unagi LLC will enlist the aid of a Qualified Intermediary (“QI”) such as Accruit to help structure its portion of the transaction as a 1031 exchange, allowing him to defer the associated taxes. The QI will work with the other professionals involved in the transaction, preparing the necessary exchange documents, and holding Unagi’s share of the sale proceeds. Within 45 days after the sale, Unagi LLC will identify appropriate replacement properties. Learn more about the Rules for Identification and Receipt of Replacement Property in a 1031 exchange. Using the exchange proceeds held by the QI, Unagi will complete the acquisition of a new property, Replacement Property, worth at least $800,000, thereby exchanging equal or up, and maximizing the value of their 1031 exchange.
The Result
Joey was able to cash out of the original investment property, pay associated taxes, and retire to Southern California, where he is now pursuing an acting career. Ross and Monica, as the two members of Unagi LLC, continue to own investment property in the Bethlehem area. Ross deferred the taxes from the sale of the original investment property by utilizing a 1031 Exchange. Those taxes will remain deferred until Ross completes a real estate transaction, if ever, without the use of a 1031 Exchange.
As always, taxpayers are encouraged to discuss their plans with their tax and legal advisors before they embark on the path toward the sale of an investment or business use property, and to engage the services of a Qualified Intermediary the first closing that will be part of their exchange.