When can partnership interests be exchanged tax-free?

• Author: Sanders, Michelle

Sec. 1031 permits the exchange of "like-kind" property without the recognition of any gain realized on the exchange. However, Sec. 1031(a)(2)(D) specifically states that "interests in a partnership" are not like-kind property.

However, flush language was added to Sec. 1031(a)(2) by the Revenue Reconciliation Act of 1990, providing an exception to this general rule. An interest in a partnership with a valid Sec. 761(a) election may be treated as an interest in each of the assets of such partnership. (Sec. 761(a) permits certain partnerships to be excluded from subchapter K.) Therefore, it is possible for an exchange of a partnership interest to qualify for Sec. 1031(a) nonrecognition treatment.

Sec. 761 defines which partnerships qualify for Sec. 760(a) elections. A partnership may make the election to be excluded from all of subchapter K if the partnership is formed

-- for investment purposes only and not for the active conduct of a business (e.g., raw land joint venture),

-- for the joint production, extraction or use of property, but not for the purpose of selling services or property produced or extracted (e.g., a typical oil and gas joint venture) or,

-- by dealers in securities for a short period, for the...