Same-Day Drop and Swap Survives in New York: What Real Estate Investors Need to Know

If you’ve ever looked into 1031 exchanges, you’ve probably heard that drop and swaps are tricky-especially when done on the same day. Most tax advisors will tell you to avoid them unless you want trouble.

But in a win for taxpayers, the New York Division of Tax Appeals recently approved a same day drop and swap. The decisions in Hadar and Shomron (DTA Nos. 850122 and 850123) are worth a close look.

Let’s break down what happened, why it matters, and how you can use this in your own 1031 strategy.

What Is a Drop and Swap?

A Quick Refresher

In a standard 1031 exchange, the same taxpayer must sell and buy like-kind property. That means if your LLC owns the property, the LLC must do the exchange – not the individual partners.

But what if the partners want to go their separate ways? Enter the drop and swap.

How It Works

In a drop and swap, a partnership (like an LLC) “drops” the property to the individual partners. Each partner then becomes a tenant-in-common (TIC) owner. Once that happens, each person can do their own 1031 exchange.

But there’s a catch…

Why It’s Risky

If the drop happens too close to the sale, the IRS or state tax agency may argue that the partnership is still the seller-not the individuals. That kills the exchange.

There is a concern that same-day drops might get flagged as sham transactions.

What Happened in Hadar and Shomron?

The Basic Facts

The two cases involved taxpayers who were members of LLCs that owned New York real estate. Just before selling the property, the LLCs distributed undivided interests in the property to the individual members. These distributions happened on the same day the properties were sold. Each individual then initiated their own 1031 exchange using their TIC share of the property.

The State Challenged the Exchange

The New York Division of Taxation said the LLC-not the individuals-was the real seller. They argued this was a step transaction, claiming there was no real change in ownership. But the taxpayers fought back-and won.

What the DTA Decided

The Taxpayers Were the Real Sellers

The DTA reviewed the facts and ruled that the individuals had validly received the property before the sale. Even though everything happened the same day, the paperwork was solid.

The deeds were recorded. The title was held by the individuals at the time of the sale. The court focused on the legal form and documentation.

No Sham Here

The DTA found that the transaction had economic substance. The LLCs properly distributed the property, and the members sold it (not the LLCs).

There was no circular movement of funds, no retained control, and no bad facts.

Why This Case Matters

It’s a Win for Same-Day Drops

This case shows that good documentation and a clean paper trail can make a difference when the timing of the drop and swap is tight. The DTA respected the legal form of the deal. That’s good news for investors.

New York Gave a Green Light (for Now)

This case happened in New York. The IRS and other states may not agree. But New York is a major tax jurisdiction. Other tax authorities often pay attention to DTA decisions.
If you’re doing deals in New York, this case opens the door to same-day drop and swaps-if done right.

Key Lessons for Real Estate Investors

1. The Paper Trail Matters

The DTA leaned heavily on the legal documentation. The deeds were signed. The title was recorded. The individual owners were listed on the closing documents.

If you’re doing a drop and swap, don’t skip the paperwork. Have your attorney:

• Prepare a formal distribution agreement
• Update the LLC operating agreement
• Draft clear TIC agreements
• Record the deeds before closing

2. Substance Still Counts

Form helps, but substance matters more. If the partnership still runs the show, the deal could fall apart. Make sure:

• The individuals take full ownership
• They assume their share of expenses
• They manage their portion independently

The more separation, the better.

3. Know Your Jurisdiction

This win happened in New York. Your state may see things differently.

For example:
California often fights drop and swaps
Texas is generally more flexible but still looks at timing
The IRS has not issued clear rules.

Talk to a tax advisor familiar with your state’s audit trends.

Should You Try a Same-Day Drop and Swap?

When It Might Make Sense

You might consider a same day 1031 drop and swap if:

• Your sale is imminent
• The partners want to go separate ways
• You don’t have time for a long holding period after the drop

But Be Careful

Even with the New York ruling, you want to make sure your paperwork is right.

Get your team involved:

• Your real estate attorney
• Your CPA
• A qualified intermediary (QI) who understands the risks

A bad drop and swap can blow up your exchange. It’s not worth the risk unless the paperwork is airtight.

Best Practices for Future 1031 Exchange Drop and Swaps

If you’re planning ahead, here’s how to do it right:

Plan Early

Ideally, make the drop several months before closing. That shows a real change in ownership.

Get Everything in Writing

Use:

• Formal TIC agreements
• Distribution resolutions
• Deeds recorded in the county
• Proof of ownership in the contract and HUD statement

Avoid Red Flags

Don’t:

• Co-mingle proceeds
• Use a joint bank account
• Let the LLC pay all expenses

Do:

• Treat each TIC owner as separate
• Show independent control
• Keep separate records

Final Thoughts

The Hadar and Shomron decisions give investors hope. Same-day drop and swaps can work if done carefully. But this isn’t a green light to get sloppy. The court rewarded solid documentation, not shortcuts.

If you’re considering a 1031 exchange drop and swap, plan ahead. Bring in your advisors early. Make sure your QI knows the details.

And most importantly, don’t assume a win just because it worked in New York.

Want Help with Your Exchange?

As a professional Qualified Intermediary, we help investors navigate complex exchanges, including drop and swaps. If you have questions or want to avoid costly mistakes, let’s talk.