Short answer: A drop and swap is a way for partners in an LLC or partnership to split up when some want a 1031 exchange and others want cash. The entity first distributes the property to its members as tenants in common (the drop), then each owner sells their share and exchanges or cashes out (the swap).
Reviewed by Jon Hilley. Last updated September 29, 2026.
A drop and swap solves a common problem among the types of 1031 exchanges: co-owners who hold property through a partnership or multi-member LLC but disagree about what to do after the sale. The LLC is the taxpayer, so normally the LLC must either exchange the whole property or sell it and pay the tax. Members cannot exchange their LLC interests, because a partnership interest is not real property.
The drop and swap converts each member's share of the LLC into a direct, undivided ownership interest in the real estate. Each owner then becomes their own taxpayer for the sale and can choose a 1031 exchange or cash independently. It works, but it carries real audit risk if it is done late or carelessly.
Key rules
- Partnership interests do not qualify: Only real property can be exchanged, so members cannot 1031 their LLC or partnership interests (IRC §1031(a)(1); Treas. Reg. §1.1031(a)-3)
- Each owner must hold for investment: After the drop, each tenant in common must hold its interest for investment or business use (IRC §1031(a)(1))
- Courts have accepted some drop and swaps: Exchanges tied to a distribution or contribution were upheld where the taxpayer kept an investment intent (Magneson v. Commissioner, 753 F.2d 1490 (9th Cir. 1985); Bolker v. Commissioner, 760 F.2d 1039 (9th Cir. 1985))
- Courts have also rejected them: Where the partnership had effectively arranged the sale before the distribution, the Tax Court treated the partnership as the seller (Chase v. Commissioner, 92 T.C. 874 (1989))
- Co-owners can elect out of partnership status: Qualifying investment co-ownership arrangements can elect out of the partnership rules (IRC §761(a))
How a drop and swap works
- The LLC deeds the property to its members as tenants in common, in proportion to their ownership. This is the drop.
- Each member holds its undivided interest as an investor for a period of time, sharing income and expenses directly.
- The tenants in common sell the property together. Each one either exchanges its share of the proceeds through its own qualified intermediary account or takes cash. This is the swap.
A variation is to drop out only the departing member's share, so the LLC keeps its remaining interest and exchanges it. Either way, every seller on the deed must be the same taxpayer that buys the replacement property.
Drop and swap holding period: why the timing matters
The weak point in most drop and swaps is intent. If the LLC signs a purchase contract and then deeds the property out days before closing, the IRS can argue that the LLC made the sale and the members simply received cash. That is the fact pattern in Chase.
No statute or regulation sets a minimum holding period after the drop. The earlier the drop happens before a sale, the stronger the position, and many advisers prefer it to happen in a tax year before the sale, or at least before any buyer signs a contract. The tenants in common should also behave like co-owners, not a partnership: separate deeds and closing statements, their own share of income and expenses, and their own decisions. Rev. Proc. 2002-22 lists conditions the IRS uses when deciding whether to rule that a TIC arrangement is not a partnership, and it is a useful checklist even if you are not asking for a ruling. The partnership return (Form 1065, Schedule B) also asks whether the partnership distributed a tenancy-in-common or other undivided interest to any partner during the year, so the drop is visible to the IRS.
States can add another layer. California's Franchise Tax Board in particular has scrutinized drop and swaps, so check the rules where your property sits on our 1031 exchange by state page.
How does a swap and drop work?
A swap and drop reverses the order. The LLC completes the 1031 exchange, then later distributes the replacement property to its members. The same holding-intent questions apply, this time to the replacement property.
Drop and swap vs. swap till you drop
"Swap till you drop" is a different idea: exchanging from property to property and holding the last one until death, so heirs receive a stepped-up basis (IRC §1014) and the deferred gain may never be taxed. It is an estate planning strategy, not a way to split up co-owners.
Example: three members, two exchanges and one cash-out
Assume an LLC with three equal members owns a building worth $3,000,000 net of selling costs, with an adjusted basis of $1,200,000 and no debt. Assume each member's share of basis is equal. Members A and B want to exchange; member C wants cash.
- Net sale price: $3,000,000
- Adjusted basis: $1,200,000
- Total gain: $1,800,000
- Each member's one-third share of proceeds: $1,000,000
- Each member's one-third share of gain: $600,000
- Members A and B, each reinvesting $1,000,000 through a 1031 exchange: $0 recognized, $600,000 deferred each
- Member C, taking $1,000,000 in cash: $600,000 recognized
- Total deferred: $1,200,000
- Total recognized: $600,000
Without the drop, the LLC could only exchange or not. If it paid C's share out in cash, that cash would be boot to the LLC, and the resulting tax would flow through the partnership. The drop and swap isolates C's tax to C. Part of C's gain reflecting prior depreciation would be taxed at up to 25%. Talk to your CPA or tax attorney about how the distribution and the gain are allocated in your situation.
Common mistakes
- Dropping too late. The riskiest pattern we see is a deed from the LLC to its members recorded the week of closing, after a buyer signed with the LLC.
- Acting like a partnership after the drop. One bank account, one set of books and a partnership return that still reports the property all undercut the claim that each owner holds its own interest.
- Overlooking the lender. Deeding mortgaged property to the members can require lender consent. Start that conversation before you record anything.
