Related Party Exchanges & pitfalls!
Related Party issues are very significant in the world of 1031 exchanges. So significant in fact that you have to disclose a Related Party Exchange on the Form 8824 when filing your taxes.
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.
Also, a taxpayer who engages in a related party exchange is not entitled to nonrecognition treatment under § 1031(a) of the Internal Revenue Code if, as part of the transaction, the related party receives cash or other non-like-kind property for the replacement property.
So, while you ARE able to do Related Party Exchanges; you just have to follow a couple of very clear parameters. For example, you own an investment property and decide that you want to sell your property, do a 1031 exchange, and buy your brother’s investment property. In order for the exchange to be valid your brother has to do a 1031 exchange as well. He cannot “cash out”.
An exchangor may SELL to a related party, because neither the exchanger or the related party is cashing out.
In either case, with limited exception, the exchangor and the Related Party will need to both hold their new properties for at least two years before selling, in order to satisfy the exchange requirements.
Who is a Related Party?
A Related Party is defined in §267(b) and §707(b)(1), namely siblings, spouse, ancestral or lineal descendants, grantor and fiduciary of a trust, two corporations with more than 50% of the stock owned by the same parties, and the list goes on.