Can You Buy 1031 Replacement Property With a Partner?

Yes. You can buy a replacement property together with someone who is not part of your exchange, such as a friend, a business partner or a relative. The usual structure is tenancy in common, where you take title to an undivided fractional share in your own name and your co buyer takes title to theirs. Only your share has to satisfy the exchange rules. The structure that causes trouble is forming a new partnership or multi member LLC with the co buyer and having that entity buy the property, because then the entity, not you, is the buyer.

How does a tenancy in common purchase work?

In a tenancy in common, each owner holds an undivided percentage interest in the whole property. Nobody owns a particular floor or unit. Each owner's interest appears on the deed, each can sell or mortgage their own share, and each reports their share of income and expenses.

For the exchanger, that fractional interest in real estate is the replacement property. For the co buyer, it is an ordinary purchase. The two of you close on the same day under the same purchase contract, but the money arrives from different places. Your exchange funds come from your Qualified Intermediary, while your co buyer brings their own cash and loan proceeds directly to closing.

Why not just form an LLC together?

This is the most common mistake. Section 1031 does not apply to interests in a partnership, and a multi member LLC is usually taxed as a partnership. If you and a co buyer form an LLC and the LLC buys the building, you have exchanged real estate for a partnership interest, which does not qualify.

It also breaks the same taxpayer rule. The taxpayer who sold the relinquished property must be the taxpayer who acquires the replacement. A new partnership is a different taxpayer.

A single member LLC that is disregarded for tax purposes is a different case. Many exchangers hold their fractional share through their own disregarded LLC, which is generally treated as owning it directly. Your attorney can explain the options for holding title.

Is every co ownership arrangement a tenancy in common?

Not automatically. If co owners run the property like a joint business, the IRS may treat the arrangement as a partnership for tax purposes, whatever the deed says. Revenue Procedure 2002-22 sets out the conditions the IRS considers when asked to rule that a co ownership is not a partnership. It is guidance for obtaining a ruling rather than a strict legal test, but practitioners use it as a reference point.

Features that tend to support a true co ownership include:

• ›Each owner holding title in their own name or a disregarded entity
• ›No filing of a partnership tax return and no operating as a business together
• ›Unanimous approval for major decisions such as a sale, a new lease or a refinance
• ›Each owner free to sell or encumber their own share
• ›Income, expenses and debt shared in proportion to ownership
• ›A property manager handling routine operations under a management agreement

A written co ownership agreement covering these points, including what happens if one owner wants to sell, is worth putting in place before closing rather than after.

What does your share need to cover?

Your fractional share has to meet the same tests as any replacement property. To defer all the gain, the value of your share should equal or exceed the value of what you sold, all of your net exchange proceeds should go into it, and debt you paid off should be replaced with new debt or additional cash.

Illustrative example only. Suppose you sold a rental for 1,000,000 dollars, paid off a 400,000 dollar mortgage and have 600,000 dollars with your Qualified Intermediary. You and a co buyer agree to buy a 2,000,000 dollar building as equal tenants in common, financed with an 800,000 dollar loan.

• ›Your 50 percent share is worth 1,000,000 dollars, matching what you sold
• ›Your share of the loan is 400,000 dollars, matching the debt you paid off
• ›Your 600,000 dollars of exchange funds cover your share of the equity
• ›Your co buyer brings 600,000 dollars of their own and takes the other 400,000 dollars of debt

Together that is 1,200,000 dollars of equity plus 800,000 dollars of debt, which equals the 2,000,000 dollar price. The example ignores closing costs and is simplified to show the arithmetic. It does not describe any real property or recommend any structure.

How do you identify a fractional interest?

You identify the property within 45 days as usual, and it is sensible to describe the interest you intend to buy, for example a 50 percent tenancy in common interest in a named address. If you are relying on the 200 percent rule, many advisers value the identification using the fractional interest you are actually acquiring, so the description matters. Your Qualified Intermediary can confirm how they want it written.

What about the loan?

Lenders often prefer one borrower. When several tenants in common borrow together, the lender may require each owner to be jointly and severally liable for the whole loan, not just their share. That is a real commercial risk if your co buyer stops paying. For the exchange analysis, the debt you assume on your share is generally what counts toward replacing the debt you paid off, but how a joint loan is allocated is a question for your CPA.

What if the co buyer is your spouse or a relative?

A spouse who was not on title to the property you sold is, for exchange purposes, a co buyer like anyone else. Adding them on your share can raise a same taxpayer question, while giving them their own separate share does not, so the vesting needs attention.

Buying from an unrelated seller alongside a relative is not a related party exchange. The related party rules apply when you buy from or sell to the relative, not when you buy beside them.

What should you settle before closing?

Co ownership is easy to enter and harder to leave. Before you sign, talk through:

• ›How decisions are made, and what happens if you disagree
• ›Who manages the property and how costs are shared
• ›What happens if one owner needs to sell, falls ill or dies
• ›Whether the other owner has a right of first refusal on your share
• ›How a future sale works if one of you wants to exchange again and the other does not

The bottom line

Buying with a partner can bring a better property within reach of your exchange, provided you take title to your own share directly and keep the arrangement a co ownership rather than a business partnership. 1031Property is a marketing and referral service and does not give tax, legal or investment advice. Review the structure, the vesting and the loan terms with your CPA, attorney and Qualified Intermediary before you go under contract.