Can You Do a 1031 Exchange With a Family Member?

A 1031 exchange is a tax-deferral strategy under Section 1031 of the Internal Revenue Code. It allows real estate investors to defer capital gains taxes by reinvesting the proceeds from the sale of one investment property into another qualifying like-kind property.

The question is: Can you do a 1031 exchange with a family member? A 1031 exchange with family is possible only 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.

IRS Rules for Related-Party Transactions

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.

Selling to or buying from any of these related parties is not automatically disallowed—but it triggers scrutiny.

When Is a Related-Party 1031 Exchange Allowed?

Every related-party transaction is unique; some may not qualify for tax deferral. You might need to follow different guidelines depending on the type of transaction you’re pursuing—intent and compliance matters. The IRS looks at whether the transaction is used to improperly cash out or avoid tax.

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. Essentially, both parties complete a 1031 exchange.

The holding period starts on the date of the last transfer and includes three exceptions:

1. Death of either related party.
2. Mandatory or involuntary conversion of either property under Section 1033.
3. 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:

1. Your related party completes their own 1031 exchange using the proceeds from your purchase.
2. You prove that the transaction didn’t result in tax evasion.

When Is It Disallowed? Common Scenarios That Fail IRS Scrutiny

These are the most common scenarios when a 1031 exchange with a family member may fail.

1. Selling your property to a family member who intends to sell it shortly after.
2. Buying a property from a family member who just sold it in a 1031 exchange.
3. Trying to transfer basis without a legitimate exchange.

The 2-Year Holding Rule: What Investors Must Know

The IRS imposes a special two-year holding requirement for 1031 exchanges involving related parties, as outlined in Section 1031(f) of the Internal Revenue Code. Under this rule, the taxpayer and the related party must retain ownership of their respective properties for at least two years following the exchange.

The intent is to prevent taxpayers from circumventing capital gains taxes through quick family transfers. If either party sells the exchanged property within two years, the IRS may disqualify the exchange retroactively, triggering capital gains taxes on the original transaction. This holds true even if both parties initially followed all other 1031 exchange rules. The IRS treats early disposition as evidence that the exchange lacked legitimate investment intent.

Exceptions to the Two-Year Holding Rule

There are limited circumstances where the two-year holding rule does not apply.

• Involuntary Conversions: If a property is lost due to condemnation, theft, or a natural disaster, the requirement may be waived.
• Transfers Due to Death: If the taxpayer or the related party passes away, the two-year rule is typically not enforced.
• Other Valid Non-Tax Avoidance Reasons: The IRS may allow exceptions if the disposition occurs for legitimate, documented reasons unrelated to tax avoidance (e.g., unforeseen financial hardship).

Investors considering a related-party 1031 exchange should consult a qualified intermediary or tax advisor to help maintain clear documentation of intent.

Best Practices Before Attempting a Transaction

Know and prepare for these best practices before ever attempting a transaction with a related party.

• Work with a qualified intermediary (QI) and tax advisor.
• Document intent to hold and use the property for investment.
• Consider using a third-party intermediary if the structure is too risky.
• Ensure the transaction is at fair market value and fully documented—1031 exchanges involving related parties must comply with IRS rules and avoid any appearance of preferential treatment.

Can You Do It? Yes—With Caution

A 1031 exchange with a family member is permitted, but only if it complies with strict IRS rules. If you swap, sell to, or buy from a related party, both sides must typically hold their respective properties for at least two years to preserve tax-deferral benefits. If you fail to meet this requirement, the IRS may disqualify the exchange, triggering an immediate tax liability.

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