Related Party Transactions

Related party exchanges are when a taxpayer does a 1031 Exchange with a person or entity that is related per the tax code. Sections 267(b) and 707(b) of the Internal Revenue Code state that persons or entities bearing a relationship to the Exchangor, such as certain members of a family (brothers, sisters, spouse, ancestors and lineal descendants) are related parties. It further states that a grantor and fiduciary of any trust, two corporations which are members of the same controlled group, and corporations and partnerships with more than 50% direct or indirect common ownership are also related.

Swap exchange with a related party
As defined under IRC §1031(f), related parties may exchange real estate assets through a “swap” transaction as long as both parties hold their Replacement Properties for a minimum of two years after the exchange. This rule prevents taxpayers from using exchanges to shift the tax basis between the properties to avoid paying taxes should one of the parties liquidate one of the properties.

Selling property to a related party
The IRS has stated through numerous Private Letter Rulings (PLRs) that there is no basis shifting when a taxpayer sells property using a Qualified Intermediary and transfers that property to a related party, as long as they acquire their replacement property from an unrelated seller. In transactions structured this way, it is recommended that both you and the related party hold the acquired property for a minimum of two years after the exchange. There have been PLRs issued (PLRs 200709036, 200712013, and 201027036) which state that the non-exchanging party could possibly liquidate their property before the two-year time period expires. Our recommendation is to always discuss with your tax professional before making this decision.

Purchasing property from a related party
These exchanges where a taxpayer were to purchase replacement property from a related party are not likely to qualify for tax deferral unless the related party seller also were to do a 1031 exchange. As stated in Revenue Ruling 2002-83, the IRS ruled that if both parties were to do 1031 exchanged with an unrelated Qualified Intermediary and neither party were cashing out their investment, as long as each were to acquire property and hold it for a minimum of two years, this could qualify. In these cases, neither party can retain a substantial amount of boot from the transaction. The IRS did rule that a small amount of boot (5% or less) should not ruin the related exchanges (see PLRs 200820017, 201048025 and 20121607).

Taxpayers wanting to perform a related party exchange should consult with their tax professionals before moving forward with this type of exchange so that the tax professional can first review the specifics of the transaction and see if the exchange can qualify following some of the exceptions that the IRS has provided.

For more information, please reach out to your tax professional for specific questions or contact the specialists here at Security 1st Exchange for assistance.