A 1031 exchange with family is possible if you adhere to strict rules and guidelines. Because the IRS has added numerous restrictions to curb tax abuse, it’s important to understand related party 1031 exchange rules.
What is a Related Party?
The IRS defines the term “related party” under Section 267(b) and Section 707(b). A related party is any entity or person that has a relationship with the exchanger, including:
- Immediate family members, such as your siblings, spouse, ancestors and direct descendants.
- Corporations, partnerships or entities in which you own more than 50% of the stock, either directly or indirectly.
- Grantors and fiduciaries of any trust.
Related Party Transactions
Every related-party transaction is unique, and some may not qualify for tax deferral. You might need to follow different guidelines depending on the type of transaction you’re pursuing.
1. Swapping With a Related Party
Under Section 1031(f), related parties can swap separately owned properties and defer recognized gain if they hold the properties for at least two years. The holding period starts on the date of the last transfer and includes three exceptions:
- Death of either related party.
- Mandatory or involuntary conversion of either property under Section 1033.
- You can prove that you aren’t using the exchange to evade taxes.
2. Selling to a Related Party
Selling to a related party and buying like-kind property from an unrelated party is possible through an intermediary. As with an exchange or swap, both parties must adhere to the two-year holding period.
3. Buying From a Related Party
Buying from a related party and selling to an unrelated party also requires a Qualified Intermediary. However, these transactions are often disqualified because they may lead to tax basis swapping. The IRS issued Revenue Ruling 2002-83 in response to the issue, clarifying that buying from a related party violates Section 1031(f)(1) and 1031(f)(4).
You can still defer income tax liabilities under specific circumstances. These exceptions include the following:
- Your related party completes their own 1031 exchange using the proceeds from your purchase.
- You prove that the transaction didn’t result in tax evasion.
1031 Exchange Related Party Rules
The IRS has used Section 1031(f)(4) to further establish related party 1031 exchange rules. Field Service Advice (FSA) Memorandum 2001-37003 states that the two-year holding period is prioritized over Section 1031(f)(4) if you adhere to the time frame. The most recent ruling, Revenue Ruling 2002-83, prevents related parties from using an intermediary to defer capital gains.
Related party 1031 exchanges can be a viable investment strategy. If you’re considering one, taking certain steps may ease the process:
- Consult a tax advisor for individualized advice.
- Account for and plan to abide by the two-year rule.
- Work with an exchange syndication platform that can help you assess your options and meet your deadlines.
- Use Form 8224 to report your 1031 exchange.
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