Exchange Planning Corporation frequently gets asked: what happens when co-owners of a property want to go in different directions at the time of sale? Some want to cash out. Others want to defer taxes through a 1031 exchange. And the property might be held in a partnership, LLC, or tenancy in common—each with its own rules.

The good news: with proper planning, there are straightforward solutions that protect everyone’s interests.

The Scenario  

You co-own a debt-free investment property worth about $1,000,000 with family members. You’ve held it for decades and have little or no basis left. Your co-owners inherited their shares and received a stepped-up basis—or they simply want the cash. They have no interest in doing a 1031 exchange. You, on the other hand, would face a massive tax bill if you sell without exchanging.

This isn’t unusual. Co-owned properties frequently reach a point where the owners’ goals diverge. The question is: can each owner do what’s best for them?

Almost always yes. But the path depends on how the property is owned.

Why Ownership Structure Matters  

The IRS is clear: you cannot 1031 exchange a partnership interest. Section 1031 explicitly excludes “interests in a partnership” from like-kind exchange treatment. If a property is held inside an LLC taxed as a partnership, individual members can’t simply sell their membership interests and exchange independently.

However, the entity itself can complete a 1031 exchange. And there are well-established strategies to accommodate partners who want different outcomes.

Three Strategies for Co-Owned Property Exchanges  

1. Buy Out the Departing Partners and Let the Entity Exchange  

If some co-owners simply want their cash, the most straightforward approach is often a buyout. The departing partners are bought out, and the entity—now with at least two remaining members—sells the property and completes a 1031 exchange.

The key requirement: the partnership or LLC must continue to have at least two members. A remaining owner could bring in a new partner for as little as 1%, or one of the departing owners could retain a small percentage. With two members still in place, the entity files returns as a partnership and can exchange without issue.

This avoids the complexity of restructuring the entity. In many cases, all that’s needed is a buyout document—something a real estate transaction attorney can draft at reasonable cost.

2. Drop and Swap  

A drop and swap works like this.  The partnership distributes the property to its members as tenants in common (the “drop”), then each tenant-in-commons either exchanges (the swap) or takes the cash and pays their tax.

At the federal level, the IRS has largely moved away from aggressively pursuing drop and swap transactions, particularly when the restructuring is done well in advance of the sale. California, however, continues to challenge these transactions with mixed success. you are considering exchanging after coming out of a partnership, Extra caution is warranted in these situations.  We recommend you contact us for preliminary guidance and to see if legal advice is warranted..

The critical distinction: drop and swap rules matter most when a partner drops out and then wants to exchange. If a partner is being dropped out at closing and simply reporting a sale, the rules are far less of a concern—they’re cashing out, and that’s straightforward.

3. Converting to a DST  

Converting the partnership into a Delaware Statutory Trust allows each beneficial interest holder to be treated as owning a fractional interest in real property. Everyone can independently decide whether to exchange or cash out.

The downside is cost—typically $20,000 or more in legal fees. For many transactions, a simpler buyout accomplishes the same goal. But if the owners, want to exchange a DST conversion may be the cleanest path.

Planning Is Everything  

The single most important factor is timing. The sooner co-owners begin discussing their exit strategy, the more options they have. Waiting until a buyer is at the table dramatically limits what can be done.

Exchange Planning Corporation’s experience with hundreds of exchanges has shown that early planning consistently produces better outcomes. Even situations that seem impossible often have solutions when the right planning is applied early enough.

What Happens After the Exchange Closes  

This is where many investors stop thinking about the exchange—and where Exchange Planning Corporation’s work begins.

Nearly half of the exchanges EPC reviews contain reporting errors that lead to overpaid taxes for years. Co-owned property exchanges are especially prone to issues: basis calculations that don’t account for each owner’s share, depreciation schedules that shortchange the building allocation, closing adjustments misreported as taxable income, and Form 8824 errors on boot calculations.

Exchange Planning Corporation’s proprietary software catches these errors, optimizes depreciation methods, and produces CPA-ready documentation. EPC fills the gap between closing and filing—the gap where most exchange errors occur.

The Bottom Line  

Co-owned property doesn’t have to mean a tax nightmare. With the right planning, each owner can pursue their own financial goals. Start the conversation early, understand how your ownership structure affects your options, and make sure the post-closing documentation is handled by a specialist.

If you or your clients are navigating a co-owned property sale and considering a 1031 exchange, schedule a complimentary consultation or call (424) 277-6011.

Frequently Asked Questions  

Q: Can I do a 1031 exchange on just my share of a co-owned property? 
A: It depends on how the property is titled. If you hold your interest as a tenant in common, you can exchange your share independently. If the property is inside a partnership or LLC, the entity itself needs to do the exchange—but there are strategies to make that work even when other owners want to cash out.

Q: What is a drop and swap, and is it risky? 
A: A drop and swap is when a partnership distributes property to its members as tenants in common before a sale, allowing and  owners  decide to exchange. At the federal level, the IRS has eased its scrutiny of these transactions. California’s Franchise Tax Board is more aggressive.

Q: How far in advance do co-owners need to plan before selling? 
A: The earlier the better. Ideally, any restructuring—whether it’s a partner buyout, a drop to tenancy in common, or a DST conversion—should happen in a tax year prior to the sale and before the property is listed. Waiting until a buyer is under contract severely limits your options.

Q: What does Exchange Planning Corporation do after a co-owned property exchange closes? 
A: Exchange Planning Corporation prepares the post-closing documentation that ensures every owner’s exchange is reported correctly. This includes adjusted basis calculations for each owner’s share, depreciation optimization, proper treatment of closing adjustments, and completed Form 8824 reporting. EPC delivers CPA-ready reports and backs every engagement with an Audit Assurance Warranty.

Q: Do I need a specialized attorney for a partnership exchange, or will any real estate attorney work?
A: For a straightforward partner buyout, a real estate transaction attorney can typically handle the documentation. If the situation requires a DST conversion or involves complex exchange structuring, you’ll want counsel with specific 1031 expertise. Exchange Planning Corporation can help connect you with the right professionals based on your situation.