The short answer
Every partner can be taxed, not just the one who receives the money. Cash kept out of the exchange is boot recognized by the partnership under section 1031(b), and that gain is allocated under the partnership agreement, usually pro rata, while the cash itself goes to one person. The distribution is a second, separate event: the partner who receives it is taxed again only to the extent the cash exceeds that partner's basis in the partnership. A valid special allocation can steer the boot gain to the partner who takes the cash, but it has to be in the agreement and has to carry real economic weight.
At a glance
| Who recognizes the boot | The partnership, under section 1031(b) |
|---|---|
| How the gain is split | By the partnership agreement, or by each partner's interest if the agreement fails |
| Cash distribution | Taxed to the recipient only above the basis of the partner's interest |
| Basis effect | Allocated gain raises a partner's basis; cash distributed lowers it |
| Amending the agreement | Allowed up to the original due date of the partnership return |
| When the cash can move | Not before the qualified intermediary may release it under the exchange agreement |
| Cleaner routes | Pre-sale tenancy-in-common deed or a buyout funded before the sale |
The boot is the partnership's gain, and the agreement decides who reports it
A partnership exchange has one taxpayer. If the partnership receives replacement property plus cash, section 1031(b) recognizes the partnership's gain up to the amount of that cash. The gain is then a partnership item like any other.
Under section 704(a), each partner's distributive share is 'determined by the partnership agreement'. If the agreement is silent, or its allocation lacks substantial economic effect, section 704(b) falls back to each partner's interest in the partnership based on all the facts. Most agreements split gain by percentage, so a three-way partnership reports the boot gain in thirds.
Each partner's share of that gain increases the basis of the partner's interest under section 705(a), which is what keeps the same dollars from being taxed twice.
The payout to one partner is a distribution with its own rule
When the partnership then hands the cash to one partner, section 731(a) says gain is not recognized 'except to the extent that any money distributed exceeds the adjusted basis of such partner's interest'. The distribution reduces that partner's basis instead.
So the partner who received the money pays tax on it only through the share of boot gain allocated to them and on any excess of cash over basis. The other partners pay tax on their allocated share of the boot even though their bank balances did not change.
The timing is also fixed by the exchange. The qualified intermediary agreement must deny the partnership any right to the money before the conditions in Reg. section 1.1031(k)-1(g)(6) are met, so the distribution usually follows the end of the exchange period rather than the sale.
Worked example: $600,000 left out of a $3,000,000 sale
Hypothetical, round numbers, no debt and no state tax; run your own numbers with your CPA. Partners A, B and C own equal thirds of a building with an adjusted basis of $1,200,000. The partnership sells for $3,000,000, reinvests $2,400,000 and distributes the remaining $600,000 to C.
Under a pro rata agreement, the $600,000 of recognized gain is split $200,000 to each partner. A and B each report $200,000 of gain with no cash. C reports $200,000, and if C's basis before the year was $400,000, it rises to $600,000 and the $600,000 distribution brings it to zero with no further gain.
With a valid special allocation of the whole $600,000 to C, A and B report nothing and C's basis rises to $1,000,000 before falling to $400,000. Because the boot comes out of a depreciated building, part or all of it may be unrecaptured section 1250 gain taxed at up to 25%, as explained in is boot taxed as recapture or capital gain first.
Fix the allocation in writing before the return is due, not after
Section 761(c) treats modifications to the agreement made by the original due date of the partnership return as part of the agreement for that year. That gives partners a window to adopt a special allocation of the boot gain to the partner taking the cash.
The allocation has to match the economics. If capital accounts and liquidation rights do not follow the allocation, it can fail the substantial economic effect test and be reallocated. Have the partnership's preparer model the capital accounts before anyone signs.
Watch debt too. If the replacement carries less debt than the property sold, each partner's share of partnership liabilities may fall, and section 752(b) treats that drop as a cash distribution; see more debt to offset cash taken out.
Two other routes keep the cash and the tax on the same person
A drop and swap deeds the departing partner an undivided interest before the sale, so that partner sells for cash and the others exchange. Timing decides whether it holds up; see drop-and-swap strategies.
A buyout funded before the sale, often with a refinance or a note, redeems the partner so the partnership can exchange 100% of the proceeds. The variations are in one partner wants cash and a partnership interest buyout.
Where the continuing partners need to replace the debt that a buyout adds, a leveraged trust interest can carry that debt without a personal guarantee, a point covered in does a DST's loan count as replacement debt.
Related questions
Can the partner who wants cash just exchange less than the others?
No. The partnership is a single exchanger, so it either reinvests the proceeds or receives boot; there is no per-partner exchange inside one entity.
Does the cashed-out partner leave the partnership?
Only if the distribution liquidates that partner's interest. A partial cash distribution leaves the partner in, with a smaller capital account and basis, so the agreement needs to say how future profits are shared.
If the boot is allocated pro rata, can the other partners get a tax distribution?
Only if the agreement provides for one or the partners agree. Nothing in section 1031 requires the partnership to give partners cash to pay tax on boot allocated to them.
Is the distributed cash subject to the net investment income tax?
The IRS lists capital gains and rental income as net investment income, so a partner's share of boot gain can be hit by the 3.8% net investment income tax once modified AGI passes $250,000 joint or $200,000 single. Whether an exception applies to your share is a question for your CPA.
Where does the partnership report the boot?
On its own Form 8824 and Form 4797, then on each partner's Schedule K-1; see how a partnership exchange is reported on the K-1.
Sources
Checked against these publications on September 30, 2026. Rules and figures change; confirm the current version with your CPA or attorney before you act. This page is general information, not tax or legal advice.
- 26 U.S.C. Section 1031, like-kind exchanges
- 26 U.S.C. Section 704, partner's distributive share
- 26 U.S.C. Section 705, partner's basis
- 26 U.S.C. Section 731, partnership distributions
- 26 U.S.C. Section 761, partnership agreement defined
- Treas. Reg. Section 1.1031(k)-1, deferred exchanges
- 26 U.S.C. Section 752, partnership liabilities
- IRS, Net investment income tax