Internal Revenue Code Section 1031 allows taxpayers to swap a business or investment property for a new business or investment property without recognizing gain on the exchange. However, these “like-kind” exchange rules do not apply to exchanges of partnership interests (Code Section 1031(a)(2)(D)).
In a recent private letter ruling, the IRS did allow partnership interests received by a taxpayer in exchange for real property to qualify for like-kind exchange treatment. However, this was not a major departure from existing law.
In the private letter ruling, the taxpayer received 100% of the partnership interests in the partnership. In that situation, the IRS was comfortable in looking through the received partnership and treating the taxpayer as having received the underlying assets of the partnership. Since the underlying partnership-owned property was of like-kind to that exchanged away by the taxpayer, like-kind exchange treatment was allowed. The IRS noted that by acquiring 100% of the partnership interests, the partnership was deemed to have liquidated and distributed its assets to its partners, and thus the acquisition was essentially an acquisition of partnership assets.
Therefore, the effect of the ruling was not to open the door to like-kind exchanges of partnership interests, but simply to acknowledge the pass-through/disregarded entity treatment that arises when 100% of the partnership interests are being transferred. Nonetheless, the ruling is helpful since the IRS is acknowledging such pass-through treatment for Section 1031 purposes.
As with all private letter rulings, the ruling is only binding on the IRS as to the taxpayer that submitted the ruling. Nonetheless, such rulings are typically (but not always) indicative of the IRS’ approach to the subject matters of the ruling.