A common problem that arises in real estate partnerships is when
there is an opportunity to sell and some partners want cash out and
some partners want to defer tax by engaging in a like-kind
exchange. The trick is to dispose of the property in a way that
protects the exchanging partners from any tax on the cash received
by the partners that want to cash out.
One solution is to distribute an undivided ownership interest (a
"tenancy in common" or "TIC" interest) in the
real estate to the partners that want to exchange. This transaction
can be effective, but it puts stress on two of the requirements for
like-kind exchanges: (i) whether the TIC interest qualifies as real
estate and (ii) whether the partner who exchanges property will be
considered to have held it for investment or for use in a business
prior to the exchange.
A better solution is for the LLC to distribute the TIC interest to
the owners who want to cash out (the "cash out members").
The LLC retains a TIC interest for the remainder of the property.
After the distribution, the LLC will be owned only by the owners
who want to make the exchange. Then the LLC and the cash out
members can each transfer their respective TIC interests in the
property, with the LLC receiving real estate in exchange for its
interest and the cash out members receiving cash. The LLC that
conducts the exchange is the historic owner of the real estate, so
there is no question of whether it held it for investment or use in
a business so provided the other requirements are met this is a
good tax-free like-kind exchange. The cash out member receives cash
and is the only person that is taxable on it.
Bottom Line: While this is a simple description of
a somewhat complicated transaction, it can be very effective for
facilitating the receipt of cash by some members and receipt of
property in a nontaxable exchange by others. Also, it is important
to distribute the TIC interests prior to entering into a purchase
agreement.
"The only difference between a tax man and a taxidermist is that the taxidermist leaves the skin." Mark Twain
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
