Section 1031 requires the same taxpayer on both sides of the deal, the sale and the replacement purchase. For a single-member LLC that is simple, because the owner is the taxpayer. For a partnership or multi-member LLC, the entity exchanges rather than the individual partners, and paying proceeds out to partners before the exchange is finished disqualifies it.
Two people buy a property together. Years later they sell it for a healthy gain, and they want different things. One wants to roll the money into another building and defer the tax. The other just wants to cash out. What happens next comes down to a single question the IRS cares about more than any other: who, exactly, is the taxpayer?
That question sits under every 1031 exchange run through an entity - the move that lets you sell an investment property and defer the capital-gains tax by rolling the proceeds into another one. The same-taxpayer rule is short: whoever sold the old property must be the one who buys the replacement. What trips people up is that "whoever" is defined by how the entity is classified for tax, not by whose name is on the deed. Three ownership structures cover most cases, and each carries its own risk.
Single-member LLCs: the IRS looks straight through
A single-member LLC is invisible to the IRS. The technical word is "disregarded": the agency looks straight through the LLC and treats the individual owner as the taxpayer. So a single-member LLC can run a 1031 exchange exactly the way a person can.
Example: Jane Smith owns a rental property in "Smith Rental Properties LLC," a single-member LLC. The LLC sells the property for $500,000 and identifies a replacement through a qualified intermediary, the neutral third party that holds the proceeds between the two sales so the seller never touches them. Jane is the taxpayer. The exchange proceeds as if she owned the property directly.
Moving a property from your own name into a single-member LLC, or back out, generally does not create a same-taxpayer problem, because the taxpayer never changed.
Partnerships and multi-member LLCs: the entity exchanges, not the partners
A multi-member LLC taxed as a partnership is its own taxpayer, separate from the people who own it. The entity does the exchanging. The members cannot split the proceeds and go their separate ways.
Example: You and a partner own a property in a two-member LLC. It sells for $500,000, with a $300,000 gain. You want to exchange. Your partner wants cash. The LLC cannot hand each of you your share and let you each go your own way. The LLC is the taxpayer, so only the LLC can identify and acquire the replacement property.
If the LLC distributes sale proceeds to its members before the exchange is finished, the exchange fails. Now the members hold the money, but the LLC is the entity that sold. The same taxpayer is no longer on both sides, and the entire deferral is lost.
The fix happens before the sale, not after: decide whether the entity is exchanging or cashing out, keep the proceeds inside the entity, and route them through the qualified intermediary. Nothing goes out to members until the exchange is complete.
Tenants-in-common: each owner decides alone
Tenants-in-common (TIC) ownership works differently. Each co-owner holds a separate, undivided interest in the property, and each is treated as an individual taxpayer. That means each owner decides for themselves whether to exchange.
Example: Two investors each own a 50% TIC interest in an office building. At sale, Investor A does a 1031 exchange with her share of the proceeds. Investor B takes cash and pays the tax. Both are acting as separate taxpayers, so both are compliant.
That independence gives TIC more flexibility for 1031 purposes than a partnership. It comes with tradeoffs elsewhere: borrowing against the property is harder, management decisions need consensus, and a future sale gets more complicated when co-owners want different things.
Changing the entity mid-exchange breaks the rule
The most common way an entity-level exchange falls apart is a change of ownership structure between the sale and the purchase of the replacement.
Picture the timeline. A partnership sells on day zero, opening an exchange window that runs to about day 180. Somewhere inside that window, the partners peel off into separate LLCs, and those new entities try to buy the replacement property. Now a different taxpayer is buying than the one that sold. The exchange is disqualified, and the full gain becomes taxable.
The IRS has a tool built for exactly this: the step-transaction doctrine, which lets it treat a string of quick moves as a single transaction. If a partnership distributes property to its members, or to new entities, shortly before or during an exchange, the agency can decide the restructuring existed only to sidestep the same-taxpayer rule, and disallow the whole thing.
If partners want the freedom to head in different directions, the restructuring has to happen well ahead of the sale - a year or more, with a documented business reason behind it. The drop and swap guide covers the timing and the risk in more detail.
When partners want different things
When one owner wants to exchange and another wants cash, the answer has to be built before the sale closes, not improvised after. A few paths:
Buyout. One partner buys out the other's interest before the sale. The remaining owner sells and exchanges individually. Clean and simple, but it takes capital.
TIC conversion. Convert from partnership ownership to tenants-in-common well before the sale, so each owner then acts independently. This needs careful planning and enough lead time to avoid a step-transaction challenge.
Partition. Divide the property into separate parcels, with each owner taking a parcel to sell or exchange on their own. Logistically complex, and it depends on the property type and local rules.
Compromise. Both partners exchange together into a single replacement property chosen for its cash flow, and the partner who wants liquidity draws it from distributions over time. Not perfect, but it avoids restructuring risk.
What the intermediary will need to see
A qualified intermediary running an entity exchange will ask for:
- Certificate of formation or articles of organization establishing the entity
- Operating agreement or partnership agreement showing tax classification and ownership percentages
- Prior-year tax returns confirming how the entity files (Form 1065 for partnerships, Form 1120-S for S-corps)
- The entity's EIN
- Written authorization (a resolution or manager consent) approving the exchange
- Confirmation that no proceeds were distributed to members before the exchange was complete
This paperwork is your defense if the IRS questions the exchange. It shows that the same taxpayer sold and bought, and that the procedure was followed.
Handshake deals: put it in writing before you sell
Many co-ownership arrangements start informally. Two people agree to buy property together with no written agreement, holding title jointly or under a casual business name.
At exchange time, that informality turns into a liability. The IRS will ask what entity sold the property, whether it was a partnership, and who the partners were. Without formal documentation, the answers are ambiguous.
Formalizing the entity - a partnership agreement or LLC operating agreement, with the certificates filed with your state - before you own the property, or at least well before you sell, removes that ambiguity. It costs a few hundred dollars and a few hours, and it heads off far larger disputes later.
Special situations
A partner dies. If a partner dies during the holding period or between sale and closing, the interest generally passes to the estate or heirs. The entity may continue and the exchange may proceed if it is properly documented. Get guidance from a tax attorney if this situation arises.
S-corps and C-corps. Corporations can exchange, but the same-taxpayer rule applies at the entity level. S-corp shareholders cannot individually exchange their share of corporate property; the corporation has to do the exchange.
Trusts. Revocable trusts (grantor trusts) are generally treated like the individual grantor for 1031 purposes. Irrevocable trusts are separate taxpayers. Confirm the trust's tax classification with your CPA before proceeding.
Three questions before you sell
Before selling property held in an entity, confirm three things with a tax professional:
- Who is the taxpayer? The answer determines who must be on both sides of the exchange.
- Do all owners agree on the strategy? Disagreements have to be resolved before the sale, not after.
- Is the entity structure documented? Formation documents, operating agreements, and tax returns should all be current and consistent.
Settle the taxpayer question before you sell. When partners want different outcomes, the restructuring has to happen early; a change made between the sale and the replacement purchase can cost the entire 1031 deferral.
Frequently asked questions
Can a single-member LLC do a 1031 exchange?
Yes. By default a single-member LLC is disregarded for tax, meaning the IRS looks through it and treats the owner as the taxpayer. The exchange works exactly as it would if that person held the property in their own name.
What if a multi-member LLC wants to do a 1031 exchange?
The LLC is the taxpayer, so the LLC does the exchange: it sells the old property and buys the replacement. Individual members cannot take their share of the proceeds and exchange separately, because that breaks the same-taxpayer rule. The same entity has to be both seller and buyer.
Can individual partners pull out and exchange their share separately if a partnership sells property?
No. The partnership is the taxpayer, so if the partnership sells, the partnership has to do the exchange. Partners cannot peel off their share of the proceeds and exchange on their own, a common mistake that disqualifies the deal.
What if partners disagree on whether to exchange? One wants cash, one wants to exchange.
Solve it before the sale. Options include restructuring into separate entities ahead of time, converting to tenants-in-common, or one partner buying the other out. Selling first and trying to sort out the disagreement afterward is too late for a 1031.
Is a tenants-in-common (TIC) structure the same as a partnership for 1031 purposes?
No. In a TIC, multiple owners each hold an interest in the property without a formal partnership, and each owner can run their own 1031 exchange, which is useful when co-owners disagree. TIC comes with its own complications, though, so consult a professional before restructuring.