The Internal Revenue Service recently issued Revenue Procedure 2002-22, providing ruling guidelines for the tax classification of undivided fractional interests in rental real property. Although we continue to find clients to whom this comes as a surprise, section 1031 of the Internal Revenue Code prominently provides that the tax-free treatment accorded to like-kind exchanges does not apply to the exchange of partnership interests. Therefore, partnership interests cannot constitute either relinquished property or replacement property in a like-kind exchange.
When confronted with this obstacle, real estate lawyers sometimes propose restructuring the partnership into a tenancy-in-common. For example, a taxpayer who transfers real property in a like-kind exchange may replace it with a 50 percent tenancy-in-common interest in a building, since the tenancy-in-common interest constitutes real property. Then, the tax lawyers “who always foul-up the deal” point out that for tax purposes a tenancy-in-common is often treated as a partnership, resulting in a disqualified exchange.
