Can You 1031 Exchange Into a Real Estate Syndication?

Usually not. Most real estate syndications are structured as an LLC or limited partnership taxed as a partnership, and investors buy membership units or partnership interests. Section 1031 applies only to exchanges of real property, and an interest in a partnership is not real property, even when the partnership owns nothing but buildings. Exchange proceeds sent into a typical syndication would generally be treated as a taxable purchase of a partnership interest, not as replacement property. There are structures designed to let exchange investors hold a share of a larger property, but they are built differently from a standard syndication.

Why is a partnership interest not like-kind?

Before 2018, Section 1031 listed property types that could not be exchanged, and interests in a partnership were named specifically. The Tax Cuts and Jobs Act narrowed Section 1031 to real property only, so the separate list mattered less, but the result for partnership interests did not change. A partnership interest is treated as an interest in an entity. It is not a direct interest in the land and buildings the entity owns.

That distinction holds even when the partnership is small, when it owns a single property, and when you know every other investor. If what you receive at closing is a membership certificate or a line on a cap table rather than a deed or a recorded interest in real estate, you have generally bought an interest in an entity.

A single member LLC is different. It is usually disregarded for federal income tax purposes, so owning real estate through one is treated as owning the real estate directly. The problem arises once the entity has two or more owners and files a partnership return.

How is a typical syndication structured?

In a common setup, a sponsor forms an LLC, raises money from passive investors, borrows the rest, and buys a property. Investors receive units in the LLC. The sponsor manages the property and takes fees and a share of profits under the operating agreement. Each year the LLC files a partnership return and sends investors a Schedule K-1.

That is a reasonable structure for cash investors, but it does not work for exchange money. The investor never holds title to the real estate. The LLC does.

Which structures can work with exchange proceeds?

There are a few ways for an exchange investor to hold a share of a larger property while staying inside Section 1031. Each has trade offs, and each should be reviewed with your CPA and your Qualified Intermediary before you commit.

Direct ownership

The simplest option is buying a whole property yourself, alone or through a single member LLC. You control it, and you carry all of the management and concentration risk.

Tenancy in common

In a tenancy in common, or TIC, each investor receives an undivided fractional interest in the real estate itself, recorded on title. Revenue Procedure 2002-22 sets out conditions the IRS considers when asked to rule that a TIC arrangement is not a partnership. These include a limit of 35 co-owners and a requirement that certain major decisions, such as selling, leasing or refinancing, need the approval of all co-owners. The co-owners also cannot file a partnership return or operate as a business entity.

Those conditions make TICs workable but sometimes difficult to run. Unanimous approval can be hard to obtain, and lenders often treat TIC loans as more complicated. Our article on exiting a tenancy in common covers the problems that can arise later.

Delaware Statutory Trust

A Delaware Statutory Trust, or DST, holds title to real estate, and investors buy beneficial interests in the trust. Revenue Ruling 2004-86 describes when a DST interest can be treated as a direct interest in real property for Section 1031 purposes. To stay within that ruling, the trustee is restricted in what it can do, which is why DSTs are passive and inflexible by design.

DST interests are securities. They are generally available only to accredited investors, are offered through a licensed broker dealer under definitive offering documents, and carry risks including illiquidity and loss of principal. The sponsor controls decisions and timing, and investors have very little say.

Section 721 contribution to an operating partnership

Some sponsors offer a path where a property, often held first in a DST, is later contributed to a REIT's operating partnership in exchange for units under Section 721. That contribution can be tax deferred, but the operating partnership units you end up with are partnership interests. You generally cannot exchange them into real estate again under Section 1031. It is a one way door, and our article on 721 exchanges sets out the questions to ask before walking through it.

Can the syndication itself do a 1031 exchange?

Yes. The entity that owns the property can sell it and exchange into other real estate at the entity level, provided the same entity is the seller and the buyer. That is a decision for the sponsor and the operating agreement, not for an individual investor. If you want to exit while the other investors want to continue, you generally cannot take your share of the property into your own separate exchange without restructuring first, which raises the drop and swap issues covered elsewhere on this site.

A short illustrative example

Illustrative example only. An owner sells a rental and has $600,000 sitting with a Qualified Intermediary. A friend is raising money for an apartment syndication and offers units in the LLC. If the owner directs the intermediary to send funds to the LLC in exchange for units, the owner has generally bought a partnership interest. That is not like-kind replacement property, so the exchange would likely fail for that portion, and the gain could become taxable. If instead the owner bought an undivided TIC interest recorded on title, or a DST interest that fits the ruling, the analysis would be different. The figures here are illustrative, and the outcome depends on the documents and facts.

Questions to ask before sending exchange funds anywhere

• ›What exactly will I receive? A deed, a recorded TIC interest, a DST beneficial interest, or units in an entity.
• ›What tax return does the vehicle file? A partnership return is a warning sign for exchange money.
• ›Has a tax professional reviewed the structure for exchange investors specifically?
• ›What control will I have, and what decisions require my approval?
• ›How and when can I exit, and can that exit itself be another exchange?

The bottom line

A typical syndication sells interests in an entity, and those interests generally do not qualify as replacement property. If you want a share of a larger property with exchange proceeds, the structure has to be built for that purpose from the start. This article is general education, not investment, tax or legal advice. Before you identify anything, ask your CPA and your Qualified Intermediary to confirm that what you are buying is real property for Section 1031 purposes.