Drop and swap

The drop and swap is the standard fix for the partnership problem: partners who own a property together but want different things at exit, some to cash out, some to keep deferring through a 1031. Because a partnership interest cannot be exchanged, the drop and swap converts each partner into a direct owner of real estate first, so each can then go their own way. It is common, it is legal, and its success depends almost entirely on getting the timing and documentation right.

How it works, step by step

The name describes the two moves. First the “drop”: before the sale, the partnership distributes the property out to the partners as tenants in common, dissolving or redeeming the partnership interests so each partner now holds a direct, undivided TIC interest in the real estate. The partnership is dropped. Second the “swap”: the former partners, now TIC co-owners, sell the property, and each independently decides what to do with their share. Those who want to defer run their own 1031 exchange into their own replacement property, using their own qualified intermediary; those who want cash take it and pay their tax.

The magic is in the conversion. Once a partner holds a TIC interest, they own real estate, not a partnership interest, and real estate is exchangeable. The rule that blocked them, partnership interests are not like-kind, no longer applies, because they are no longer exchanging a partnership interest.

The drop and swap distributes the property to partners as tenants in common before the sale, converting each partnership interest into exchangeable real estate so partners can pursue separate exits.

The risk: held for investment, and the timing question

The whole structure rests on one requirement, and it is where drop-and-swaps live or die. To qualify for a 1031, each exchanger must have held the relinquished property for investment. When a partner receives their TIC deed shortly before the sale, the IRS can argue they did not hold that interest for investment long enough, that the drop was just a device to enable individual exchanges, and disqualify the exchange.

The conventional defense is seasoning: complete the drop well before the sale, often cited as a year or more, ideally spanning two tax years, so the TIC ownership looks like genuine investment rather than a closing-table maneuver. Longer holding, clear documentation of investment intent, and consistent tax reporting before and after the drop all strengthen the position.

The exchange can fail if the IRS decides the partner did not hold the TIC interest for investment, so the safest drop-and-swaps season the distribution well before the sale, often across two tax years.

The 2025 case that softened the timing orthodoxy

Here is a recent development that matters, because it cuts against the “you must season for two years or you lose” fear. In 2025, the New York Division of Tax Appeals upheld a drop and swap in the Hadar case where the partnership distributed TIC interests to its members essentially the same day as the sale. The judge held that the brief time the members held title as tenants in common was not, by itself, determinative. What carried the day was the partners’ long-held investment intent, their consistent planning, and their execution of the sale as separate individual taxpayers.

The lesson is not that timing is irrelevant, it is that intent and documentation are what actually decide these cases, and a well-documented, long-standing investment posture can survive even a same-day drop. Seasoning still makes the position stronger and safer, but the substance, genuine investment intent held over the life of the property, is the real test. This is a state administrative decision based on federal authorities, not binding precedent everywhere, but it is a meaningful data point that thoughtful drops can hold up.

A 2025 decision upheld even a same-day drop where the partners showed long-held investment intent, confirming that documented substance, not just the calendar, is what decides a drop and swap.

The bottom line

• A drop and swap converts partnership interests into direct TIC real estate ownership before a sale.
• Each former partner can then independently 1031 into replacement property or cash out.
• The key risk is the “held for investment” requirement when the drop happens close to the sale.
• Seasoning the drop, ideally across two tax years, with strong documentation, is the safe approach.
• A 2025 decision upheld a same-day drop on strong intent, confirming substance matters more than the calendar.

For the problem it solves, read partnership issues in a 1031. For the mirror-image structure, see swap and drop. For the full picture, start at the 1031 exchanges and exit planning hub.

Last verified August 2026.