What happens if two or more taxpayers own property together, as tenants in common, and decide that they want to go their separate ways?
Additionally, what happens if one of the taxpayers decides they want to do a 1031 Exchange and the other owner, decides it wants to just receive its share of the proceeds and pay its tax?
Before we get to answering the above questions, we need through some definitions.
Partition is defined as dividing an interest into different parts.
Tenants in common are defined as ownership by two or more people, where the share of ownership may be unequal; and each owner can freely transfer its interest of ownership to others, during their lifetime and/or through a will.
That means that any of the owners can dispose of its interests to whomever they wish while they are alive or leave their ownership interests to their heirs. There is no “right of survivorship” going to the other owners.
Sounds very technical. Let me give you a couple of examples that I believe will help simplify and educate at the same time.
EXAMPLE #1: X, Y, & Z each own an undivided 1/3 interest in an investment piece of real estate together as Tenants in Common. They no longer want to own property together; they find a buyer for the property they own together and then each finds a property they would like to own 100% of by themselves.
Question: Can X, Y, & Z, sell the property they jointly own and each do their own separate 1031 tax-deferred exchange, resulting in each of them deferring taxes on their taxable gain?
Answer: Yes, they can. But they must still satisfy 3 requirements: (1) there must be an exchange; (2) the real estate exchanged must be like-kind; and (3) the properties must be held for the productive use in a trade or business or for investment.
The result is that X can accomplish a valid Section 1031 exchange by obtaining its own separate Replacement Property; Y can accomplish a valid Section 1031 exchange by obtaining its own separate Replacement Property and Z can accomplish a valid Section 1031 exchange by obtaining its own separate Replacement Property. They no longer are forced to own property together.
Let me give you another example of a partition of a Tenants in Common property.
EXAMPLE #2: Similar factual pattern. X, Y & Z each own an undivided 1/3 interest in an investment piece of real estate as Tenants-in-common. They no longer want to own property together. They find a buyer for the property they own together. X and Y each want to do a Section 1031 Tax Deferred exchange and each finds their own Replacement Property they would like to own by themselves. Z would like to just cash out and pay its taxes.
Question: Can X and Y separately do a Section 1031 Exchange, obtaining their own Replacement property and Z receive its proceeds and then pay its taxes?
Answer: Yes, this also can be accomplished. Both X & Y must still satisfy the 3 requirements mentioned above and Z, upon receiving its payout would then be responsible for payment of any taxes due on its individual ownership of the Relinquished Property. This works because the parties held their interests as Tenants in Common, not as an interest in a partnership or corporation.
One final comment: It is ALWAYS advisable that the Taxpayer speaks with their Legal and Financial counsel whenever dealing with an involuntary conversion. Liberty 1031 LLC looks forward to working with you on future Section 1031 transactions.
I personally look forward to working with you on your next Section 1031 exchange.
