How to Approach Related Party 1031 Exchanges

Many taxpayers have questions about related-party 1031 exchange transactions. The IRS has imposed special rules that limit your ability to do like-kind exchanges with related parties. In particular, when you’re buying a replacement property, you have to be careful so that your transaction isn't deemed to be motivated by an intention to avoid the imposition of tax. It’s often hard to discern any difference between the legal intention to defer taxes and the improper intention of avoiding the imposition of tax.

But if both the party that’s acquiring the property and the party that’s selling the property aren’t paying any taxes, that might be a perfect storm for the IRS to be worried about.

What is a Related Party?

Your parents, your children, ancestors, and anyone to whom you’re related by blood or familial relationship are considered related parties. In addition to that, you can be a related party with people that you’re in business with (partners, people that are in corporations or trusts with you, etc.).

Looking at your specific situation and working with your tax advisor is essential if you’re considering doing a related party exchange. Many people think that all they have to do is hold the property for two years and they’ll have satisfied the related party rules. But there's more to it than that.

You also can't have an intention to avoid the imposition of the tax. The IRS has litigated cases that have further muddied the waters and made it hard to navigate what is and is not appropriate. Anyone considering buying a property from a related party should do so with their eyes wide open and work with their accountant and tax advisor to make sure that they're doing it right. If you want to avoid all of these hassles, just don't buy from a related party.

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

Defer the tax. Maximize your gain.

© 2019 Copyright Jeffrey R. Peterson All Rights Reserved

Two Rules About Related Parties in a 1031 Exchange

1031 exchanges between “related parties” are somewhat common, but can present a host of additional issues. As a result, it’s important to understand the requirements and restrictions of related party 1031 exchanges. In this article, we are going to discuss three rules to remember about related parties in a 1031 exchange.

Defining Related Party

A related party for the purposes of a 1031 exchange is defined in Sections 267(b) and 707(b) of the Internal Revenue Code. Related parties include, but are not limited to, immediate family members, such as brothers, sisters, spouses, ancestors and lineal descendants. Related parties do not include stepparents, uncles, aunts, in-laws, cousins, nephews, nieces and ex-spouses.

Holding Requirement

Another issue you need to be cognizant of with related party exchanges is timing. As a general rule, you and your related party should hold your properties for a minimum of two years after the exchange. If either property is disposed of before this two year holding period, the exchange will be disallowed. There are a few rare exceptions to this rule, but it’s a good general guideline to follow.

CPEC1031

At CPEC1031, LLC, we specialize in facilitating 1031 exchanges of real estate for taxpayers in Minnesota and around the United States. Our intermediaries have more than two decades of experience, and work tirelessly to ensure that your exchange is a success. Contact us today to learn more about the services we have to offer and set up an appointment with one of our team members. Our main office is located in downtown Minneapolis but we have satellite offices in other states as well.

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

Defer the tax. Maximize your gain.

© 2019 Copyright Jeffrey R. Peterson All Rights Reserved

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

What is a Related Party When it Comes to a 1031 Exchange?

The IRS is paranoid of related party transactions and they're more so concerned about your buying your 1031 replacement property from a related party. So what is a related party in a 1031 exchange?

Blood Relatives

A related party can be related to you by their business affiliation or blood relationship. So your mother, your father, your sister, your brother - these are all people that are related to you by blood. Under the statutes, if you are acquiring the property from them you need to disclose that on form 8824 and there are complications that stem from your acquisition of the property from a related person.

First you have to hold the property for 2 years and there cannot be an intent to avoid the imposition of the tax which really means it can't be part of a scheme to avoid taxes.

Business Affiliates

Now the other way a person could be related to you is by business affiliation. So you could be buying your replacement property from a partnership that you are the majority partner in or a corporation that you're the majority shareholder in.

There are other situations in which the seller would be considered to be a related party. Here is a listing of what the IRS considers “related parties”:

• Members of a family, including only brothers, sisters, half-brothers, half-sisters, spouse, ancestors (parents, grandparents, etc.), and lineal descendants (children, grandchildren, etc.);

• An individual and a corporation when the individual owns, directly or indirectly, more than 50% in value of the outstanding stock of the corporation;

• Two corporations that are members of the same controlled group as defined in §1563(a), except that "more than 50%" is substituted for "at least 80%" in that definition;

• A trust fiduciary and a corporation when the trust or the grantor of the trust owns, directly or indirectly, more than 50% in value of the outstanding stock of the corporation;

• A grantor and fiduciary, and the fiduciary and beneficiary, of any trust;

• Fiduciaries of two different trusts, and the fiduciary and beneficiary of two different trusts, if the same person is the grantor of both trusts;

• A tax-exempt educational or charitable organization and a person who, directly or indirectly, controls such an organization, or a member of that person's family;

• A corporation and a partnership if the same persons own more than 50% in value of the outstanding stock of the corporation and more than 50% of the capital interest, or profits interest, in the partnership;

• Two S corporations if the same persons own more than 50% in value of the outstanding stock of each corporation;

• Two corporations, one of which is an S corporation, if the same persons own more than 50% in value of the outstanding stock of each corporation; or

• An executor of an estate and a beneficiary of such estate, except in the case of a sale or exchange in satisfaction of a pecuniary bequest.

• Two partnerships if the same persons own directly, or indirectly, more than 50% of the capital interests or profits in both partnerships, or

• A person and a partnership when the person owns, directly or indirectly, more than 50% of the capital interest or profits interest in the partnership.

Start Your 1031 Exchange: If you have questions about related parties in a 1031 exchange, feel free to call me at 612-643-1031.

Defer the tax. Maximize your gain.

© 2017 Copyright Jeffrey R. Peterson All Rights Reserved