The short answer
The partnership interest exclusion is the rule that an interest in a partnership, including a multi-member LLC taxed as a partnership, is not property that can be exchanged tax-deferred under section 1031. It sat in the statute as section 1031(a)(2)(D) until 2017 and now appears in Reg. section 1.1031(a)-3(a)(5), which lists partnership interests among intangibles that are never real property. The one exception is a partnership with a valid election under section 761(a) to be excluded from all of subchapter K.
At a glance
| What is excluded | Interests in a partnership or an LLC taxed as one, whatever state law calls them |
|---|---|
| Where the rule lives now | The real property definition in Reg. section 1.1031(a)-3 |
| The exception | A co-ownership that has validly elected out of all of subchapter K under section 761(a) |
| Who can exchange | The partnership itself, as owner of the real estate, not the partners individually |
The exclusion moved from the statute into the real property regulations in 2017.
Before the 2017 tax act, section 1031(a)(2) listed six kinds of property that could not be exchanged, and item (D) was 'interests in a partnership'. Public Law 115-97 limited section 1031 to real property, rewrote paragraph (a)(2) to cover only real property held primarily for sale, and moved the 761(a) sentence into a new section 1031(e).
The exclusion did not disappear. The 2020 regulations define real property and then say that interests in a partnership, other than one with a valid 761(a) election, are not real property 'regardless of the classification of such property under State or local law'. The Instructions for Form 8824 repeat the same list of intangibles that are never real property.
Under section 1031(e), an interest in an electing partnership is treated as an interest in each of its assets. Reg. section 1.761-2(a) limits the election to co-owners who hold investment property as co-owners, reserve the right to take or dispose of their shares separately, and do not actively conduct a business.
A hypothetical: the LLC can exchange its building, but a member cannot exchange a membership interest.
Hypothetical figures: three friends own a $3,000,000 warehouse through an LLC that files a partnership return. One member wants to roll a one-third interest into a Delaware Statutory Trust while the other two want to keep the building.
The member cannot sell the one-third membership interest and buy replacement real estate under section 1031, because the relinquished property is a partnership interest. The LLC, as owner of the warehouse, is the taxpayer that can exchange it, and then the replacement belongs to the LLC. Members who want separate outcomes usually look at restructuring before the sale, which is covered in drop and swap strategies. Run your own numbers with your CPA.
It bites when owners split up, buy into funds, or hold co-owned property that behaves like a partnership.
The exclusion works in both directions. Sale proceeds cannot buy an LLC or limited partnership interest in a syndication, which is why exchanging into a syndication LLC interest fails where a direct deeded interest would not.
Co-ownership can also become a partnership without anyone filing papers. Rev. Proc. 2002-22 sets the conditions under which the IRS would rule that undivided interests in rental property are not a business entity, including a limit of 35 co-owners and a bar on filing a partnership return. Rev. Rul. 2004-86 treats a properly restricted Delaware Statutory Trust as a grantor trust, so each investor owns an undivided share of the real estate, and notes that a trust whose trustee has broader powers becomes a partnership that cannot use the 761(a) election.
Related questions
Is a single-member LLC interest excluded too?
A single-member LLC that has not elected corporate treatment is usually disregarded, so its owner is treated as owning the real estate directly. See can an LLC do a 1031 for how that works.
Can a partnership make the 761(a) election just to allow an exchange?
Only if it qualifies: the members must own the property as co-owners, keep the right to dispose of their shares separately and use it for investment rather than an active business. Under Reg. section 1.761-2(b) the election is made on a timely partnership return for the first year exclusion is wanted, and it is generally irrevocable while the organization qualifies.
Does a DST interest count as a partnership interest?
Not when the trust follows the limits in Rev. Rul. 2004-86, which treats it as a grantor trust whose investors own undivided interests in the real estate. The details are in DST like-kind qualification.
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.