The section 1031(f) related party guidelines were intended to prevent taxpayers from using 1031 exchanges to shift their tax cost basis between properties owned by related parties. You may not sell a property to, or buy a property from, a related party if your motive is tax avoidance.

For example, lacking restrictions, a taxpayer with a low basis property could exchange for a property owned by a related party with a high basis position. The low basis taxpayer defers the tax liability through the 1031 exchange, while the related party with the high basis may cash out and incur a materially less tax liability than the exchanger had they cashed out and paid the tax.

Related party transactions are easily identifiable as form 8824, which is included on the federal tax return documenting the exchange, includes disclosures pertaining to related party transactions. 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) and include:

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;
• 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.

BUYING FROM A RELATED PARTY

Generally, taxpayers should not receive replacement property from a related party who is “cashing-out” in a three-party 1031 tax-deferred exchange, unless the related party is also doing an exchange or if you can prove that tax avoidance was not a motivation. If the related party selling the replacement property is also completing their own 1031 exchange, the related party must complete their exchange and both parties must hold the properties for two subsequent years. Similarly, if you have a direct swap with a related party that can also potentially qualify so long as the two-year hold is met. In each instance neither party has cashed out, and therefore is not deemed to be any tax avoidance.

SELLING TO A RELATED PARTY

A taxpayer can sell the relinquished property to a related party and acquire like-kind replacement property from a non-related party without violating the related party rules and guidelines. The related party must hold the relinquished property acquired from the taxpayer for a minimum two years and, similarly, the taxpayer must hold the replacement property acquired as part of the 1031 exchange for at least two years in order to qualify for tax-deferred treatment.

To sum it up, If the buyer and seller are related, and one of the parties ends up with the property and the other ends up with the cash, the 1031 exchange will likely be questioned.

Legal 1031 Exchange Services, LLC 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 to facilitate your exchange. © 2024 Legal 1031 Exchange Services, LLC All rights reserved.