Making A Tax-Free Exchange Of Partnership Property

There are many limited partnerships that own rental property. Suppose a real estate limited partnership plans to sell rental property of the partnership to a third party and one or more of the partners wants to defer tax through a tax-free exchange (rather than receiving cash for their partnership interests). It is important that the proper procedure be followed so that an actual exchange takes place between the partners seeking a tax-free exchange and the third party. The partners desiring the exchange will have to follow these rules:

  • Each partner seeking a tax-free exchange receives a distribution from the partnership by way of a deed of an undivided interest in the partnership property.
  • The partner then identifies property he wishes to receive in exchange, and the property is purchased by the third party.
  • The third party then exchanges this property for an undivided interest of the partner seeking the exchange.

In a 1989 Tax court decision, a tax-free exchange was lost because Chase (the partner seeking the exchange) failed to observe a few simple requirements. (Chase, 92 TC 874 (1989).

The requirements were as follows:

  • The deed to Chase from the partnership of his undivided interest was not recorded.
  • Since the partnership agreement barred distribution of property other than cash to the limited partners, this provision had to be waived by the partnership. However, no evidence was presented of such waiver.
  • There was no evidence that Chase negotiated on his own behalf.
  • During the time that Chase supposedly was the owner of the undivided interest in the partnership property, he received no rental income or credit from the partnership for rental income it received on his behalf.

 

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