Partnership's like-kind exchange dilemma?

• Author: Daniel, Charles

Sec. 1031(a)(1) provides that no gain or loss is recognized on an exchange of property held for productive use in a trade or business or for investment if the property is exchanged solely for like-kind property to be held either for productive use in a trade or business or for investment. The taxpayer recognizes gain only to the extent of money or other property received in the exchange.

Regs. Sec. 1.1031(b)-1(c) states that consideration received in the form of an assumption of liabilities (or a transfer subject to a liability) is to be treated as "other property or money." When each party to an exchange either assumes the other party's liability or acquires property subject to a liability, in determining the amount of other property or money, consideration given in the form of an assumption of liabilities (or the receipt of property subject to a liability) is offset against consideration received in the form of an assumption of liability (or transfer subject to a liability).

Example: B has a $40,000 adjusted basis in real property X, which has a $100,000 fair market value (FMV) and is encumbered by a $30,000 mortgage. On May 17, 1991, B transfers X to C, who assumes the mortgage. On July 5, 1991, C transfers real property V, which is encumbered by a $20,000 mortgage and has a $90,000 FMV, to B, who assumes the mortgage. The consideration B received in the form of the liability C assumed ($30,000) is offset by the consideration B gave by assuming the $20,000 liability; the net amount, $10,000, is treated as money or other property. Thus, B recognizes $10,000 gain; sec Regs. Sec. 1.1031(k)-1(j)(3), Example (5).

Under Sec. 752(b), any decrease in a partner's share of partnership liabilities is treated as the partnership's distribution of money to the partner. The partner must recognize income to the extent that the deemed distribution exceeds his or her adjusted basis in his or her partnership interest (immediately before the deemed distribution); see Sec. 731(a). Conversely, under Sec. 752(a), any increase in a partner's share of partnership liabilities is treated as the partner's contribution of money to the partnership.

Potential Problem

Based on the interplay of Secs. 1031 and 752, when an exchange straddles two years, partners could realize income in the year the partnership relinquishes property subject to debt, even though, in the following year, the entity timely receives replacement property encumbered by debt equal to or greater...