Yes. An LLC taxed as a partnership can exchange qualifying real estate under Section 1031 while using available cash to redeem a departing member. The LLC must qualify as the exchanger, and the partners must separately account for the sale gain and the buyout. Paying all the closing cash to one partner does not, by itself, put all the taxable gain on that partner’s Schedule K-1.
Who completes the exchange?
If the partnership owns and transfers the property, have the partnership acquire and hold the replacement property for business or investment. A redemption pays the outgoing owner for an interest in the partnership. The owner’s interest generally cannot be exchanged under Section 1031. See IRC §1031 and the federal real property definition.
Before the sale closes, have the partnership sign its qualified intermediary (QI) agreement and coordinate assignment notices and wire instructions with the buyer and closing agent. The buyer can pay taxable sale proceeds or cash boot directly to the partnership while exchange funds go to the QI under the safe harbor. Identify what the contract transfers and which consideration the cash represents. A wire designation alone cannot establish whether it is proceeds of a separate sale or boot from the exchange. Keep QI-held funds unavailable for the redemption. See Treas. Reg. §1.1031(k)-1 and our 1031 exchange planning guide.
When can the partner leave?
If the parties can wait, completing the replacement acquisition before the redemption avoids changing the exchanger’s ownership during the deferred exchange. A two-member LLC that drops to one tax owner normally becomes a disregarded entity under the federal default rules, even if the LLC continues under state law. If an earlier redemption depends on admitting a new member, review whether that person will have a genuine interest with capital at risk and enforceable economic rights before the departing member’s interest ends. Review the governing agreement, valuation, funding, and effective times of each step. See IRS guidance on LLC classification and IRC §708.
Identify replacement property within 45 days after the first relinquished transfer in the exchange. Acquire it within 180 days or by the partnership’s return due date, including extensions, whichever comes first. If the unextended return deadline would shorten the exchange period, arrange a timely extension.
Can the partnership allocate all taxable gain to the departing partner?
Start with the partners’ rights to the sale economics under the operating agreement. Under Section 704(b), a special allocation generally needs substantial economic effect or must reflect the partners’ interests in the partnership. Test whether it changes what the partners are entitled to receive before tax, including under the liquidation waterfall. An amendment that assigns all the gain to the partner taking cash, with the same fixed buyout and the same pretax rights, is vulnerable to reallocation. Under the varying-interest rules, extraordinary sale items generally follow the partners’ interests in those items at the time they arise. Record the actual sequence when a sale and a redemption occur on the same day. See Treas. Reg. §1.704-1 and Treas. Reg. §1.706-4.
Check contribution history and prior revaluations. Section 704(c) may require an uneven allocation for existing built-in gain. A permitted book revaluation tracks the economic value already held by the partners and can create a book-tax difference. Any tax-basis adjustment for retained property depends on separate rules, including §§734(b), 754, and 755 where applicable. Recapture can also have its own allocation rules. See our guides to contributed property and partnership basis and capital accounts, and the IRS’s §754 guidance.
Fictional example with a sale, exchange, and redemption
Two equal members own a debt-free LLC with two rental properties. The LLC sells one for $600,000 with a $200,000 adjusted tax basis and uses a QI to exchange the other. Assume full deferral on the exchanged property and no selling costs, ordinary recapture, special allocations, or other basis changes.
- Asset sale. The LLC recognizes $400,000 of gain. Under equal sharing, each member reports $200,000.
- Outside basis. The departing member starts with $100,000 of outside basis. The allocated $200,000 of sale gain increases that basis to $300,000.
- Redemption. After acquiring the replacement, the LLC pays $500,000 to liquidate the departing member’s interest. Assuming the payment is entirely a distribution for the interest and no hot-asset rules apply, the departing member recognizes $200,000 of additional gain on cash in excess of basis. The continuing member still reports their $200,000 share of the asset sale gain.
Model the two tax events together before setting the buyout price. In an actual deal, depreciation, partnership liabilities, the character of the payment and the parties’ other tax attributes can affect the result. See IRC §705, IRC §731 and our sale-versus-redemption guide.
What to confirm before closing
- Closing counsel. Confirm the signed purchase and redemption terms, asset values, ownership at each transfer, member approvals, and any releases from continuing guarantees.
- CPA. Reconcile asset basis, historical depreciation, book capital, outside basis and prior Section 704(c) schedules. Model each partner’s gain, tax character, cash, and estimated-tax needs.
- QI and closing agent. Reconcile the purchase agreement, assignments, wire instructions, replacement title, and deadlines before the relinquished transfer.
If the assets include wireless infrastructure, see how to evaluate towers, ground leases and equipment separately.
Review the exchange and buyout before signing
Schedule a $500 Tax Attorney Consultation with Philip Falco, Attorney & CPA. Bring the operating agreement, purchase agreement, proposed closing sequence, and basis schedules. The fee covers up to one hour total for document review, analysis, preparation, and the call. Written opinions, transaction modeling, drafting, and implementation require a separate engagement.
Federal authorities checked November 12, 2026. The example is fictional. The tax result depends on the transaction documents and facts.