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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.

A 1031 exchange is a powerful tool that can help investors defer taxes when they sell one investment property and buy another. However, there are some common mistakes that investors make during the process that can cost them time and money. In this article, we will discuss some of the most common mistakes to avoid in a 1031 exchange.
Mistake #1: Not understanding the 1031 Exchange timeline
The IRS has specific rules and timelines that must be followed in a 1031 exchange. Investors have 45 days from the sale of their relinquished property to identify potential replacement properties and 180 days to complete the purchase of one or more of those identified replacement properties. Failure to meet these deadlines will result in the disqualification of the 1031 exchange, meaning that the investor will be responsible for paying taxes on any capital gains realized from the sale of the relinquished property.
Mistake #2: Not using a 1031 Exchange Qualified Intermediary
A Qualified Intermediary (QI) is a third-party facilitator that through a series of assignments acts as the party to complete the exchange with the Exchanger. By virtue of these assignments, title to the Relinquished Party passes through the QI to the Buyer, and title to the Replacement Property passes through the QI to the Exchanger. Title does not actually vest in the QI, saving a legal step, and in many states, additional transfer taxes. The QI ensures a valid 1031 exchange by properly structuring the exchange per IRC 1031, preparing all necessary exchange documents, and monitoring the exchange to ensure continued compliance throughout the process. Failure to use a QI can result in missteps causing the disqualification of the exchange and the loss of tax deferral benefits.
Mistake #3: Not properly identifying replacement property
Investors must follow strict identification rules when selecting replacement properties in a 1031 exchange. They must identify potential replacement properties within 45 days of the sale of their relinquished property, and they must follow one of three identification rules: the Three-Property Rule, the 200% Rule, or the 95% Rule. (These rules are discussed in more detail here: [insert blog link]) Failure to properly identify replacement properties can result in the disqualification of the exchange.
Mistake #4: Mixing personal and business property
A 1031 exchange is only applicable to investment or business property. It cannot be used for personal property, such as a primary residence. Mixing personal and business property can result in the disqualification of the exchange, unless great care is exercised in structuring the exchange.
Mistake #5: Not consulting with a tax professional
The rules and regulations surrounding a 1031 exchange can be complex and confusing. It is important to consult with a tax professional who is familiar with the intricacies of the process to ensure that all requirements are met and mistakes are avoided. Failure to consult with a tax professional can result in costly errors and the loss of tax deferral benefits.
In conclusion, a 1031 exchange can be an effective way to defer taxes on investment properties. However, it is important to understand the rules and requirements of the process in order to avoid common mistakes that will result in the disqualification of the exchange. By working with a Qualified Intermediary and consulting with a tax professional, investors can ensure a successful 1031 exchange and maximize their tax deferral benefits.