The Drop and Swap — When Partners Want Different Exits

The classic partnership deadlock: the building is selling, two partners want to exchange, one wants cash. Partnership interests can’t be exchanged (excluded from 1031 outright) — but real estate held as tenants-in-common can, per owner. The drop and swap converts one into the other.

The mechanics

Before sale, the partnership “drops” title: distributing TIC interests in the property to the partners, dissolving or shrinking the entity. Each former partner now owns real estate directly — and at closing, each “swaps” (or doesn’t) individually: two run exchanges through their own QIs, one takes taxable cash. Everyone gets their own answer instead of the partnership’s single one.

The timing problem

The IRS position: property must be held for investment by the exchanging taxpayer, and a TIC interest received days before closing looks held-for-sale, not held-for-investment. Practitioners’ answer is seasoning — dropping title well before the sale (a year-plus draws comfort; months invite argument) and behaving like TIC owners in the interim: separate treatment on returns, TIC agreements, direct expense sharing. Courts have been friendlier than the IRS here (Bolker, Magneson), but late drops are litigation tickets. California adds its own pressure — the FTB actively questionnaires drop-and-swaps (VERIFY current enforcement posture with counsel).

Planning order beats cleverness

Done right, this is a calendar item, not a courtroom one: raise the exit question with partners years before any sale, drop early if paths might diverge, paper the TIC period honestly. And when the drop is already late, consider alternatives — a partnership-level exchange with the cash-out partner redeemed via refinancing, or the swap-then-drop inversion — with real counsel at the table. The multi-property mechanics often pair with these files.