For property owners and investors contemplating Section 1031 like-kind exchanges, the “drop and swap” technique continues to gain traction, even under legal scrutiny.
This approach is commonly used when real property is held in a partnership, but not all the partners want to pursue an IRC Section 1031 like-kind exchange (or the same exchange). To address this, the partnership distributes undivided interests (tenancy-in-common interests, or TIC interests) in the property to individual partners. Each partner can then choose how to proceed with their share. In practice, the distribution (the drop) occurs at the proverbial 9 a.m., followed closely by the exchange (the swap) at 9:15 a.m.
Despite favorable analogous federal caselaw, tax treatises generally contain the disclaimer that there is some question as to whether such momentary holding of the property by the TIC holder satisfies the “held for productive use in a trade or business or for investment” requirement for property relinquished in a like-kind exchange.
Recently, New York State weighed in with a taxpayer-friendly decision, In re Hadar, N.Y. Tax App. Trib., No. 850122, 6/12/25. In this case, the New York Division of Taxation disallowed like-kind exchange treatment, claiming the distributing partnership was the true seller and that the TIC holders hadn’t held the property long enough.
On appeal, the Tax Appeals Tribunal rejected this view. The ruling emphasized that Section 1031 doesn’t impose a minimum holding period, or any other arbitrary duration.”
The Hadar decision follows a similar taxpayer-friendly decision from 2020 by the California Office of Tax Appeals, In the Matter of the Appeal of Sharon Mitchell (OTA Case No. 18011715). However, despite the Sharon Mitchell decision, the California Franchise Tax Board still regularly audits drop and swap transactions, contending that this structure does not hold up under the substance over form doctrine. Although the IRS isn’t bound by state decisions, these consistent interpretations may influence how it views short-term TIC holdings.
What This Means for Business Leaders
If you’re considering a like-kind exchange and are navigating the complexities of partnership-held property, the drop and swap may still be a viable strategy. However, state-level guidance like the Hadar decision may carry persuasive weight but doesn’t guarantee IRS acceptance.
Before taking action, work closely with your tax advisor to evaluate the risks, review your partnership structure, and align your exchange strategy with evolving legal interpretations.
Ready to take the next step in your exchange planning? Connect with a member of our real estate team for guidance tailored to your situation.
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