Related Party Overview
§1031 EXCHANGE – RELATED PARTY CONSIDERATIONS
Rev. Rul. 2002-83, 2002-49 I.R.B. 927
Section 1031(f) provides special rules for property exchanges between related parties. Under § 1031(f)(1), a taxpayer exchanging like-kind property with a related person cannot use the nonrecognition provisions of § 1031 if, within 2 years of the date of the last transfer, either the related person disposes of the relinquished property or the taxpayer disposes of the replacement property. The taxpayer takes any gain or loss into account in the taxable year in which the disposition occurs. For purposes of § 1031(f), the term “related person” means any person bearing a relationship to the taxpayer described in § 267(b) or 707(b)(1).
Related party defined. For purposes of the like-kind exchange rules, the definition of related parties is a combination of related parties as defined under IRC section 267(b) and section 707(b). Combining these two sections, related parties include the following:
- Family members (siblings, spouses, ancestors, and lineal descendants);
- An individual and an entity (corporation or partnership) where the individual owns either directly or indirectly more than 50% in value of the entity;
- Two entities in which the same individual owns directly or indirectly more than 50% of each;
- Two corporations part of the same controlled group;
- An estate in which the taxpayer is either the executor or beneficiary of the estate; and
- A trust in which the taxpayer is the fiduciary and the related party is a beneficiary either of that same trust or a related trust or a fiduciary of a related trust.
Section 1031(f) is intended to deny nonrecognition treatment for transactions in which related parties make like-kind exchanges of high basis property for low basis property in anticipation of the sale of the low basis property. The legislative history underlying § 1031(f) states that “if a related party exchange is followed shortly thereafter by a disposition of the property, the related parties have, in effect, cashed out’ of the investment, and the original exchange should not be accorded nonrecognition treatment.” H.R. Rep. No. 247, 101 superst Cong. 1 superst Sess. 1340 (1989).
To prevent related parties from circumventing the rules of § 1031(f)(1), § 1031(f)(4) provides that the nonrecognition provisions of § 1031 do not apply to any exchange that is part of a transaction (or a series of transactions) structured to avoid the purposes of § 1031(f)(1). The legislative history underlying § 1031(f)(4) provides:
If a taxpayer, pursuant to a pre-arranged plan, transfers property to an unrelated party who then exchanges the property with a party related to the taxpayer within 2 years of the previous transfer in a transaction otherwise qualifying under section 1031, the related party will not be entitled to nonrecognition treatment under section 1031
Accordingly, under § 1031(f)(4), if an unrelated third party is used to circumvent the purposes of the related party rule in § 1031(f), the nonrecognition provisions of § 1031 do not apply to the transaction.
In PLR 200728008 the IRS reaffirmed that a sale to a related party may not be subject to the two-year rule. An exchanger sold two relinquished properties via qualified intermediaries to a related party in two separate reverse exchanges. Similar to PLR 200712013, issued earlier in 2007, the IRS ruled that gain was not triggered under section 1031(f)(1), despite the representation that the related party intended to sell the relinquished properties within two years, because no related party swap had occurred. The IRS also ruled that section 1031(f)(4) would not prevent nonrecognition treatment because the transactions were not designed to avoid the purposes of section 1031(f)(1) as no basis shift had occurred. PLR 200728008 reinforced the notion, first articulated in PLR 200712013, that you can sell relinquished property via a qualified intermediary to a related party as long as no basis shift occurs.
Renting to a Related Party
Section 1031 does not specifically reference the position on renting a property to a related party. However, Section 280A(d) addresses business deductions on property which is used for “personal use” by the taxpayer. For these purposes, “personal use” includes use by the taxpayer, or by any family member of the taxpayer, unless the family member uses the unit as a principal residence and is paying fair market rent. This may be considered in evaluating one’s 1031 options in such instance.
Legal 1031 Exchange Services does not provide tax or legal advice, nor can we make any representations or warranties regarding the tax consequences of your exchange transaction. Property owners must consult their tax and/or legal advisors for this information. Our role is limited to serving as qualified intermediary/accommodator to facilitate your exchange.