Oftentimes when a partnership plans to sell real estate, some partners want to cash out while other want to roll over into other real estate tax-free.  The challenge is that if the partnership receives cash in part to pay to the partners cashing out, then all the partners would be taxed on their percentage of that cash. 

As discussed in a prior “Did You Know,” one way to do address this is through a “drop and swap.”  Another alternative is to use a partnership installment note (“PIN”) transaction.  In a PIN transaction, the partnership sells its property to a buyer in exchange for cash (which a qualified intermediary will use to buy replacement property) and an installment note in the amount necessary to cash out the departing partners. The note could provide for payment of most of the note shortly after the sale and a small payment shortly after the end of the year.  The partnership then transfers the note to the departing partners in complete redemption of their partnership interests.

As long as at least one payment under the note is due after the end of the tax year, the gain on the note will be taxed only when the payments are received.  As a result, neither receipt nor distribution of the note by the partnership triggers tax to the partnership or the partner. The partner is taxed when he or she receives the payments from the buyer.  (Note this strategy can result in a portion of the departing partner’s gain being taxed at a 25% rate rather than 20% rate.)

Bottom Line: When some partners want to cash out while others want to defer tax, a PIN transaction may be the answer.  It may be a particularly effective solution when distribution of an interest in the property would violate loan covenants.

Intaxication: Euphoria at getting a refund from the IRS, which lasts until you realize it was your money to start with. ~From a Washington Post word contest