When the Partnership is Over
Welcome to the final installment in our three-part series on related-party issues in a 1031 Exchange. In Part 1, we laid the foundation. In Part 2, we dove deep into the challenges that arise inside family-related ownership structures. This concluding Part 3 focuses on something equally complex, but far more common in today’s investment world:
Business partnerships made up of unrelated parties and when the partners want out.
Investors, colleagues, friends, syndicate members, equity partners – different goals, different life stages, different strategies. At some point, one partner wants to exit, while another wants to keep the asset, and someone else wants to 1031 into something completely different.
When that happens, related-party considerations and partnership tax rules collide. And the results can be messy unless planned for properly.
The Business Partnership Reality: No Two Investors Stay on the Same Timeline Forever
Real estate partnerships usually start with energy and alignment:
- Shared capital
- Shared vision
- Shared risk
- Opportunity to buy bigger and better assets
Fast forward 7–10 years, and reality kicks in:
- One partner needs liquidity.
- Another wants to retire.
- A third wants out of management-heavy real estate.
- Someone else wants to 1031 into passive NNN income.
- Another partner doesn’t want to sell at all.
This is the moment where unrelated business partnerships become just as challenging as family ones—because the structure rather than the family relationship creates the complication.
Why Partnerships and 1031 Exchanges Collide
The biggest misconception about partnerships and 1031s is this:
Partners do not own real estate. Partnerships own real estate.
And the 1031 Exchange applies only to real property, not to partnership interests.
So when partners disagree on whether to sell or exchange, the entire structure becomes an obstacle.
Here are the three primary friction points:
1. The partnership can exchange — but individual partners cannot.
If the partnership sells, the partnership must be the taxpayer completing the 1031 Exchange.
Individual investors cannot break off at the last minute and attempt their own separate exchange.
2. Individual buyouts trigger taxable events.
If a partner is “cashed out” from the proceeds of a sale:
- That partner is taxed.
- The distribution may create boot for others.
- And the structure risks violating 1031 requirements.
The Most Common Solution: The Drop-and-Swap
For partnerships taxed as LLCs, the most practical way to accommodate diverging partner goals is the drop-and-swap, a two-step process:
- Drop:
The partnership distributes undivided, deeded interests in the real estate to one or more partners.
Those partners now hold TIC (Tenants-in-Common) interests directly. - Swap:
- The TIC holders who want out can sell or complete their own 1031 Exchange.
- The remaining partners can either:
- Exchange together as a partnership, or
- Exchange individually as TICs.
This structure allows everyone to pursue their preferred strategy without forcing uniformity.
However, drop-and-swap is not a loophole.
It must meet strict standards:
- Proper timing
- Documented investment intent
- No disguised sales
- Respecting the “held for investment” requirement
- Advance planning, not last-minute scrambling
When executed correctly, drop-and-swap can elegantly solve partnership divergence. When rushed or done without guidance, it can collapse an entire exchange.
What NOT to Do (Common Mistakes That Kill Exchanges)
Here are the most frequent missteps that unrelated partners make:
🚫 Trying to 1031 a partnership interest
Not allowed. Ever.
🚫 Distributing sale proceeds to one partner during the exchange
Creates boot or taxable gain.
🚫 Reorganizing ownership days before closing
The IRS has seen this movie before. It doesn’t end well.
🚫 Selling first, restructuring second
If the sale already occurred, it’s too late to salvage tax deferral.
The Best Strategy: Plan Years Ahead, Not Weeks
Most partnership problems don’t come from disagreement—they come from timing.
A well-run partnership:
- Anticipates exit strategies
- Reviews partner timelines annually
- Updates operating agreements with 1031 language
- Plans restructures long before a sale
- Engages tax attorneys, CPAs, and QIs early
1031 Exchanges aren’t complicated when partners share the same goals. They become complicated when everyone’s goals diverge, but the right planning gives each partner the freedom to pursue their own future.
Final Thoughts
Non-family partnership issues are often more technical than emotional. But they are just as disruptive to a 1031 Exchange when partners cannot agree on the same direction. The structure itself, not the relationship, becomes the hurdle.
The good news?
With the right planning and the right structure, partners can separate respectfully, strategically, and with full tax deferral intact.
If your partnership is approaching a sale, restructuring, or exit scenario, and you want to protect your 1031 options, reach out anytime. I help investors navigate this process every day, and the earlier you start the conversation, the more options you have.
We Are Here to Help!
If you are an investment property owner, schedule a no-obligation strategy call with me at www.Best1031Online.com, or contact James Bean
of SVN-Rich Investment Real Estate Partners, CA DRE# 01970580, at 805-779-1031
or email at james.bean@svn.com.
If you are an agent/broker, I am happy to discuss strategies with you on how to best serve your next listing client in preparing them for a successful exchange. Please visit the site and click on the Agent’s button located at the top right-hand corner of the Home Page!
Don’t know what certain terms mean?
Click here for a Glossary of Terms: https://www.svn-best1031online.com/glossary/
Stay Connected with Best 1031 Online!
Want more insights on 1031 Exchanges, real estate strategies, and smart planning to preserve both wealth and family harmony?
Subscribe to my YouTube channel, Best 1031 Online!, where I release monthly episodes of QI Corner and other expert content designed to keep you informed and ahead of the curve.
Subscribe to Best 1031 Online!
I cannot do this alone!
This Channel would not exist if it weren’t with the daily support of CRE Task Wizard!
Go visit CRE Task Wizard at https://cretaskwizard.com/ to see how they can get you doing what you are best at, doing deals!
Please stay tuned and follow me on LinkedIn, X, Instagram, TikTok & Facebook @1031BrokerJames.
All information is deemed to be accurate and is not tax or legal advice. All investors/taxpayers should consult their CPA, tax attorney and investment advisors.