Related Party 1031 Exchange Best Practices

In a related party 1031 exchange, you must hold the replacement property (that you receive from the related party) for two years. However, the other big requirement is that the exchange cannot be part of a transaction (or series of transactions) structured to avoid the imposition of the tax. If both you and your related party seller are not paying any tax (because the seller is taking a Section 121 principal residence exclusion), then you may be deemed to have crossed into the category of avoiding the imposition of the tax in 1031(f)(4).

Special Rules for Exchanges Between Related Persons

In general, If—

• (A) a taxpayer exchanges property with a related person,

• (B) there is nonrecognition of gain or loss to the taxpayer under this section with respect to the exchange of such property (determined without regard to this subsection), and

• (C) before the date 2 years after the date of the last transfer which was part of such exchange—

  • (i) the related person disposes of such property, or

  • (ii) the taxpayer disposes of the property received in the exchange from the related person which was of like kind to the property transferred by the taxpayer,

there shall be no nonrecognition of gain or loss under this section to the taxpayer with respect to such exchange; except that any gain or loss recognized by the taxpayer by reason of this subsection shall be taken into account as of the date on which the disposition referred to in subparagraph (C) occurs.

Certain Dispositions not Taken into Account

For purposes of paragraph (1)(C), there shall not be taken into account any disposition—

• (A) after the earlier of the death of the taxpayer or the death of the related person,

• (B) in a compulsory or involuntary conversion (within the meaning of section 1033) if the exchange occurred before the threat or imminence of such conversion, or

• (C) with respect to which it is established to the satisfaction of the Secretary that neither the exchange nor such disposition had as one of its principal purposes the avoidance of Federal income tax.

Related Person

For purposes of this subsection, the term “related person” means any person bearing a relationship to the taxpayer described in section 267(b) or 707(b)(1).

Treatment of Certain Transactions

This section shall not apply to any exchange which is part of a transaction (or series of transactions) structured to avoid the purposes of this subsection.

• Start Your Exchange: If you have questions about exchanges between related parties, feel free to call me at 612-643-1031.

Defer the tax. Maximize your gain.

© 2017 Copyright Jeffrey R. Peterson All Rights Reserved

1031 Exchanges Between Family Members

Generally, related party 1031 transactions should be avoided, especially as to the purchases of replacement property. We'll explain why in this article.

Would a Taxpayer be Able to 1031 into a Piece of Land Owned by His or Her Daughter?

Internal Revenue Code (“IRC”) Section 1031 (f) has special rules for exchanges between related persons that may require the related parties to hold their respective properties for two years after an exchange. However 1031 (f) also contains a killer clause that the related party exchange cannot be part of a transaction structured to “avoid” the imposition of tax. It’s hard to discern a compelling differentiation between the intention to legally and indefinitely defer one’s taxes and an impermissible intention to avoid the imposition of tax. The IRS has picked up on this and has successfully fought some heart-breaking cases. The result is that there are a string of unfriendly tax court cases and rulings that have really muddied the waters for related party purchases.  In one case a son purchased his replacement property from his mother…and the IRS disallowed the 1031 exchange.

“Related Person”

The term “related person” means any person bearing a relationship to the taxpayer described in section IRC Sections 267 (b) or 707 (b)(1) and can broadly include family members and people you are in business relationships with (such as a partnership, corporation or trust). To make matters more complicated, because of the IRS’s rules of attribution, a person may be considered to be a related person even if you wouldn’t normally consider them a related to you.

The problem for farmers who want to buy adjoining land, and families with closely located properties that they know and understand, is that these desirable replacement properties may be owned by related parties, such as an uncle, mother or brother.

• Start Your Exchange: If you have questions about 1031 exchanges between family members, feel free to call me at 612-643-1031.

Defer the tax. Maximize your gain.

© 2017 Copyright Jeffrey R. Peterson All Rights Reserved