A drop and swap is a strategy that lets the individual owners of a jointly held property go their separate ways in a 1031 exchange. The partnership or LLC first drops the property down to its members as direct tenants-in-common (TIC) interests, and each owner can then swap their share doing a 1031 exchange, or cashing out independently. It solves a common problem: a partnership interest itself does not qualify for a 1031 exchange, so the entity has to convert to direct real-property ownership first.

What is a drop and swap in a 1031 exchange?

A drop and swap is the process of converting partnership (or multi-member LLC) ownership of a property into individual tenants-in-common ownership so each owner can independently choose to do a 1031 exchange or sell. It’s used when co-owners disagree on the exit some want to defer taxes with a 1031, others want the cash.

Why it’s needed: Section 1031 specifically excludes interests in a partnership from tax-deferred treatment. Only the underlying real property qualifies. So if a partnership sells and distributes cash, each partner is taxed nobody can do their own 1031. The drop and swap restructures ownership before the sale so each person holds real estate directly.

How does a drop and swap work, step by step?

The typical sequence:

  1. Drop: The partnership/LLC dissolves its interest in the property and deeds direct TIC interests to each individual owner. Each owner now holds a fractional interest in the real estate itself.
  2. Hold: The owners hold their TIC interests for a period of time (see the holding-period section below this is the sensitive part).
  3. Swap: When the property sells, each owner independently decides what to do with their share:
    • Do a 1031 exchange into a replacement property (or a passive option like a DST), or
    • Sell their share and pay the tax.
  4. Each participating owner uses a qualified intermediary to complete their own exchange, on their own timeline, into their own replacement property.

What is the difference between a “drop and swap” and a “swap and drop”?

  • Drop and swap: convert to TIC before the sale, then each owner exchanges. Most common.
  • Swap and drop: the partnership completes the 1031 exchange first, then distributes the replacement property to the partners later. This can strengthen the “held for investment” position for the entity, but complicates the individual outcomes.

The right order depends on the facts a QI and CPA should model both. Contact an exchange officer to talk through which fits your partnership.

What is the biggest risk with a drop and swap?

The main risk is the held for investment requirement. To qualify for a 1031, the taxpayer must have held the relinquished property for investment or business use. In a drop and swap, an owner receives their TIC interest shortly before the sale so the IRS can argue the interest wasn’t truly “held for investment,” disqualifying the exchange.

Ways practitioners reduce this risk:

  • Time. Completing the drop well before the sale (often cited as a year or more, spanning two tax years) strengthens the held for investment intent.
  • Documentation. Clear records showing the TIC owners’ investment intent.
  • Consistent tax reporting. How the property is reported before and after the drop matters.

This is exactly where a CPA and QI matter most. The strategy is legal and widely used, but the execution details determine whether it survives IRS scrutiny.

When should a partnership consider a drop and swap?

Consider it when:

  • Co-owners want different exits some want to reinvest tax-deferred, others want cash.
  • A partner is retiring or leaving and wants to cash out while others continue investing.
  • Owners want to diversify into different replacement properties instead of one shared property.
  • A partner wants a passive replacement (like a Delaware Statutory Trust) while others want active real estate.

What are the alternatives to a drop and swap?

If the holding-period risk is a concern, alternatives include:

  • Deploying proceeds into a DST a partner who wants out of active management can 1031 into a Delaware Statutory Trust for passive, fractional ownership.
  • Partnership installment note (PIN) / “deferred” structures spread the tax over time.
  • Special allocations within the partnership.
  • Selling the partnership interest directly to remaining partners.

Related reading: Partnership strategies in a 1031 exchange · Single-member LLCs as tenants in common

Thinking about splitting a partnership before a sale?

A drop and swap has to be structured carefully and timed right. Talk to a 1031X exchange officer about whether it fits your situation, at no cost.

Part of our 1031 Investor Center your complete guide to 1031 exchanges.