There is more than one way to accomplish a 1031 exchange. For example, you might conduct a reverse 1031 exchange or a build-to-suit exchange rather than a traditional transaction. As an investor, your main concern is the deferral of your tax liability and taking the best route to achieving that goal.
Drop and swap transactions may assist partnerships that need to convert their ownership interests to tenancy-in-common interests before they can conduct a 1031 exchange. As it turns out, when there is 1031 exchange partnership interest, there are other methods that can be employed to take advantage of section 1031. One of those methods is the partnership installment note.
PIN Transactions Help Avoid Taxable Gain Derived from Cash Boot
In many situations, a partnership isn’t able to use section 1031 because one or more of its members don’t wish to participate in the 1031 exchange. The purpose of the partnership installment note (sometimes referred to as a “PIN” transaction) is to allow the members who do not wish to participate to leave without triggering any taxable gain.
The method works like this: the departing partner receives an installment note, which is commensurate with his or her ownership interest in the partnership. The installment note essentially functions as a “promissory note” from which the departing partner will eventually collect cash. However, because the cash never flows through the partnership entity itself, the remaining partners will not incur any taxable gain.
If the partnership entity were to receive cash to “cash out” the departing partner, then all of the remaining partners would incur some amount of taxable gain because the cash would be regarded as taxable boot. The PIN method allows partnerships to bypass this issue by compensating the departing partner(s) in a delayed fashion.
When the PIN Method May Not Work for Partnership Interests
Clearly, the PIN method provides an attractive option for investors who wish to invoke section 1031 but who must contend with a disinterested partner. However, the PIN method is not ideal in every situation.
If the departing member has a very high partnership percentage that must be cashed out, then the PIN method may not be the best solution. Or, if the departing partner wishes to receive the funds he or she is entitled to quickly, then the PIN method will likely be inadequate because it requires more time to complete.
The PIN method also complicates the exchange, so the partnership using this method will likely pay a somewhat higher-than-normal fee to its qualified intermediary. The PIN method also may raise legal issues about 1031 eligibility depending on the partnership’s unique situation. That’s why it can be helpful to work with a management firm with teams experienced in these sorts of transactions.
Work with Experts on Your 1031 Exchange Strategy
The partnership installment note method is an intriguing option for partnerships that have one or more partners who are not interested in participating in a 1031 exchange. Partnerships that don’t want to use other alternatives—such as a drop and swap—may find that the PIN route offers the best possible solution for them. It’s important, however, for each individual partnership to look carefully at its own situation and make the most well-informed decision.
One of the best ways to do that is to work with a 1031 exchange expert. At CWS Capital Partners, we’ve spent decades partnering with investors on their 1031 exchange transactions.
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The information provided here is for your general informational purposes only. It should not be considered a recommendation or personalized advisory advice. CWS has made this third party information available from authors it believes are knowledgeable and reliable resources. However, its accuracy or completeness cannot be guaranteed and sentiment may change due to legal or economic conditions.
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