A key issue when addressing exchanges involving
partnerships is to first determine whether the entire partnership wants to do an exchange or whether one or more of the partners elect to defer capital gain taxes under IRC §1031. As long as the partnership meets the requirements that apply to any exchange transactions (i.e. both the relinquished and replacement properties will be held for investment or income purposes,) then the entire partnership can do a valid tax deferred exchange.
The more commonly asked question is
"Can one or more partners drop out of the partnership and exchange their interest for a like-kind replacement property?" Since an interest in a partnership is personal property, one possible solution is to liquidate the partnership under IRC §708 so that each partner will now own their respective interest as tenants-in-common with the other former partners.
If either the entire partnership or one or more parties to the partnership receive a direct interest in the underlying assets of a liquidated partnership interest, the next key issue to do determine is if the relinquished property was considered to be held for productive use in a trade or business or for investment purposes. Both the IRS and the Tax Court seem to utilize the substance-over-form doctrine in situations like these. In both Bolker v. Commissioner, 753 F2d. 490 (1983) and Magneson v. Commission, 760 F2d. 1039 (1985), the taxpayer's transaction qualified under IRC §1031.
Transactions of this type can be complicated and should be carefully reviewed by qualified tax and legal counsel to determine whether the facts and circumstances are strong enough to support a defensible tax deferred exchange. For example, in Chase v. Commissioner, 92 T.C. 53 (1989), the taxpayer did not properly liquidate a partnership interest prior to an exchange and was denied non-recognition treatment.
Dissolving a Partnership
