1031 Exchanges With LLCs, Partnerships, and Multiple Owners

The "same taxpayer" rule is the foundation of every entity-level 1031 exchange: the entity that sells the relinquished property must be the same entity that acquires the replacement property. How that rule applies depends entirely on how the entity is classified for tax purposes. This page covers the four most common ownership structures and the specific risks each one creates.

Structure 1: Single-member (disregarded) LLC

A single-member LLC is disregarded for federal tax purposes. The IRS looks through the LLC and treats the individual owner as the taxpayer. This means a single-member LLC can execute a 1031 exchange exactly like an individual.

Example: Jane Smith owns rental property in "Smith Rental Properties LLC," a single-member LLC. The LLC sells the property for $500,000 and identifies replacement property through a qualified intermediary. Jane is the taxpayer. The exchange proceeds as if she owned the property directly.

Key point: Changing from personal ownership to a single-member LLC (or vice versa) generally does not create a same-taxpayer problem because the taxpayer identity does not change.

Structure 2: Multi-member LLC or partnership

A multi-member LLC taxed as a partnership is a separate taxpayer. The entity itself must do the exchanging. Individual members cannot split the proceeds and exchange separately.

Example: You and a partner own property in a two-member LLC. The LLC sells for $500,000 with a $300,000 gain. You want to exchange. Your partner wants cash. The LLC cannot distribute proceeds to each of you and let you each go your own way. The LLC is the taxpayer. Only the LLC can identify and acquire replacement property.

If the LLC distributes sale proceeds to members before completing the exchange, the exchange is disqualified. The members are now the ones holding funds, but the LLC is the entity that sold. The same-taxpayer rule is broken, and the entire deferral is lost.

Protection: Before selling, agree on whether the entity is exchanging or cashing out. If exchanging, keep proceeds in the entity and route them through the QI. Never distribute proceeds to members until the exchange is complete.

Structure 3: Tenants-in-common (TIC) co-ownership

Under TIC ownership, each co-owner holds a separate undivided interest in the property. Each co-owner is an individual taxpayer. This means each owner can independently decide whether to exchange.

Example: Two investors each own a 50% TIC interest in an office building. At sale, Investor A does a 1031 exchange with her share of the proceeds. Investor B takes cash and pays the tax. Both are acting as separate taxpayers, so both are compliant.

TIC ownership gives partners the most flexibility for 1031 purposes, but it has other complications: lending can be more difficult, management decisions require consensus, and future sales become more complex if co-owners diverge.

Structure 4: Same-taxpayer failures (entity changes mid-exchange)

Changing the ownership structure between the sale and the replacement-property acquisition is the most common source of entity-level exchange failures.

Why mid-exchange changes are dangerous:

DANGER ZONE: Entity changes during the exchange window

Day 0                        Day 45                       Day 180
  |                            |                            |
  |--- Partnership sells ----->|                            |
  |                            |                            |
  |    Partners form separate  |                            |
  |    LLCs during this window |                            |
  |                            |--- New LLCs try to buy --->|
  |                            |                            |
  RESULT: Different taxpayer sold than bought.
          Exchange disqualified. Full gain taxable.

The IRS applies the step-transaction doctrine to restructurings that occur in close proximity to a sale. If a partnership distributes property to individual members (or new entities) shortly before or during the exchange, the IRS may conclude the restructuring was done solely to manipulate the same-taxpayer rule and disallow the exchange.

Safe approach: If partners need ownership flexibility, restructure well in advance (12+ months before sale) with a documented business purpose. See the drop and swap guide for details on restructuring timing and risk.

Handling partner disagreements before sale

When one partner wants to exchange and another wants cash, the solution must be implemented before the sale, not after. Options include:

Buyout. One partner buys the other's interest before the sale. The remaining owner sells and exchanges individually. Clean and simple, but requires capital.

TIC conversion. Convert from LLC/partnership ownership to TIC ownership well before the sale. Each owner then acts independently. This requires careful planning and sufficient lead time to avoid step-transaction challenges.

Partition. Divide the property into separate parcels. Each owner takes a parcel and sells (or exchanges) independently. This is logistically complex and depends on the property type and local regulations.

Compromise. Both partners agree to exchange together into a replacement property that generates high cash flow. Over time, the partner who wants liquidity receives distributions. Not perfect, but avoids restructuring risk.

Documentation for entity exchanges

A QI facilitating an entity exchange will need:

• Certificate of formation / articles of organization establishing the entity
• Operating agreement or partnership agreement showing tax classification and ownership percentages
• Prior-year tax returns confirming how the entity files (Form 1065 for partnerships, Form 1120-S for S-corps)
• Entity EIN
• Written authorization (resolution or manager consent) approving the exchange
• Confirmation that no proceeds were distributed to members before exchange completion

This documentation protects you if the IRS questions the exchange. It demonstrates that the same taxpayer sold and bought, and that proper procedures were followed.

Informal arrangements: formalize before you sell

Many co-ownership arrangements start informally: two people agree to buy property together without a written agreement, holding title jointly or under a casual business name.

When it comes time to exchange, this informality becomes a liability. The IRS will ask what entity sold the property, whether it was a partnership, and who the partners were. Without formal documentation, the answers are ambiguous.

Formalize your entity before you own property, or at minimum well before you sell. Establish a partnership agreement or LLC operating agreement. File the necessary certificates with your state. The cost is modest (a few hundred dollars and a few hours of effort) and prevents significant disputes later.

Special situations

Deceased partner. If a partner dies during the holding period or between sale and exchange closing, the decedent's interest generally passes to the estate or heirs. The entity may continue and the exchange may proceed if properly documented. Get guidance from a tax attorney if this situation arises.

S-corps and C-corps. Corporations can exchange, but the same-taxpayer rule applies at the entity level. S-corp shareholders cannot individually exchange their share of corporate property. The corporation must do the exchange.

Trusts. Revocable trusts (grantor trusts) are generally treated like the individual grantor for 1031 purposes. Irrevocable trusts are separate taxpayers. Confirm the trust's tax classification with your CPA before proceeding.

Before you sell property held in an entity

Confirm three things with a tax professional:

1. Who is the taxpayer? The answer determines who must be on both sides of the exchange.
2. Do all owners agree on the exchange strategy? Disagreements must be resolved before the sale, not after.
3. Is the entity structure documented? Formation documents, operating agreements, and tax returns should all be current and consistent.