Related Parties in 1031 Exchanges: Who (or What) Qualifies?

While Section 1031 of the Internal Revenue Code allows a taxpayer to conduct a like-kind exchange with a “related” party and still receive indefinite tax deferral on any gain realized in the exchange, special rules apply. Related parties include immediate family members, business entities in which a taxpayer holds a majority interest, other qualifying affiliated businesses, and fiduciaries. Learn more from a 1031 exchange expert at 1031 National Services.

Under Section 1031 of the Internal Revenue Code (IRC), a taxpayer must relinquish ownership of the taxpayer’s relinquished property during a like-kind exchange. This relinquishment must occur in a bona fide transaction, and the transaction must not be conducted solely to “evade or defeat tax” owed to the federal government.

However, Section 1031 specifically allows taxpayers to conduct like-kind exchanges with “related” parties in qualifying circumstances. While special rules apply, meeting them gives taxpayers an opportunity to secure indefinite tax deferral in circumstances where it would otherwise be disallowed.

What is a “Related Person” Under Section 1031?

Section 1031(f) of the IRC uses the term “related person” to describe exchange parties that trigger application of the special rules we just mentioned (we discuss these rules in detail below). In doing so, it refers to two other sections of the IRC: Section 267(b) and Section 707(b)(1).

When read together, these sections establish each of the following as a “related person” for purposes of Section 1031 compliance:

• Immediate family members (siblings, spouses, ancestors, children and other lineal descendants);
• Companies in which the exchanger owns greater than a 50-percent interest;
• Companies that are part of the same control group (affiliated companies and subsidiaries); and
• Trustees and other qualifying fiduciaries.

If an exchange party does not qualify as a “related person,” then the standard rules for like-kind exchanges apply. However, if an exchange party does qualify as a “related person,” the exchanger must meet additional requirements in order to claim indefinite tax deferral.

What Are the Requirements for a 1031 Exchange Involving a “Related Person?”

When a like-kind exchange involves a “related person,” an additional two-year holding period applies. Under Section 1031(f), each related party must hold its replacement property for at least two years. While there are exceptions, these exceptions only apply in limited circumstances—specifically:

• The death of the exchanger or a related person;
• Compulsory or involuntary conversion of a replacement property under Section 1033; or
• The exchanger’s demonstration to the Internal Revenue Service (IRS) that “neither the exchange nor such disposition had as one of its principal purposes the avoidance of Federal income tax.”

Due to the complexity of Section 1031’s related party rules—and the implications of interpreting or applying these rules incorrectly—taxpayers that are contemplating a related-party exchange should consult with a qualified expert before moving forward.

FAQs: The “Related Person” Rule for Like-Kind Exchanges Under Section 1031

What if the “related person” is only involved in one side of a like-kind exchange?

The discussion above generally applies in scenarios involving a “swap” of like-kind properties between “related persons.” If a “related person” is only involved on one side of an exchange, the tax treatment depends on whether the “related person” is acquiring the relinquished property or selling the replacement property.

Can a related party acquire the replacement property (or properties) involved in a 1031 exchange?

Under the IRS’ “same taxpayer” rule, the taxpayer that sells a relinquished property and the taxpayer that acquires a replacement property do not necessarily have to be the same individual or entity. For example, under the “same taxpayer” rule, you can establish a new trust or single-member LLC to hold the replacement property in qualifying circumstances, and spouses and business partners can be added as co-owners of replacement properties.

How We Can Help

If you have questions about conducting a like-kind exchange involving a related party, we can help you do everything that is required to secure indefinite tax deferral under Section 1031 of the IRC. Each 1031 exchange expert at 1031 National Services has extensive experience in this area, and we can use our experience to help you navigate the process successfully. Contact us to learn more.

Schedule a Call with a 1031 Exchange Expert Today

To speak with a 1031 exchange expert at 1031 National Services about conducting a like-kind exchange involving a related party, contact us today. Call us at 888-872-1031 or contact us online to schedule a free, confidential consultation.