Related Parties in 1031 Exchange

Two of the more common questions that we receive as a Qualified Intermediary are being addresses in

this month’s newsletter – doing an exchange with a related party and the same taxpayer requirements

for the 1031 exchange. We hope that you find this information valuable in your business.

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.