In 2002, the IRS issued a ruling which reduces taxpayer flexibility when they complete a 1031 exchange by buying property from a relative. Revenue Ruling 2002-83 eliminated the opportunity for related parties to exchange property using a qualified intermediary (QI) when, as part of that transaction, one of the related parties received cash or other non-like-kind property in the exchange. This ruling becomes an obstacle for like-kind exchange transactions between related parties that are already subject to other restrictions.
Simultaneous exchange between related parties
In the simultaneous exchange with a related party, deeds are traded. Section 1031(f) allows this "swap" of properties with a relative provided both parties hold the property received for at least two years following the exchange. This rule was imposed to prevent taxpayers from using exchanges to shift the tax basis between the properties with the intended purpose of avoiding paying taxes.
Sale of relinquished property to a related party
A related party can buy relinquished property from the taxpayer. If they do so, Section 1031(f) requires a two-year minimum holding requirement during which the related party cannot sell the property they acquired from the taxpayer following the exchange. However, in Private Letter Rulings 200709036 and 200712013, the IRS took the position that there had been no attempt at basis shifting and no tax avoidance motive, and the exchanges were allowed. The related parties had acquired the relinquished properties from the taxpayers at fair market value, and planned to sell the properties within two years. Since Private Letter Rulings apply solely to the taxpayer requesting the ruling, review with counsel when including a 1031 exchange transaction with a related party.
Purchase of replacement property from a related party
The IRS takes a different view on buying a replacement property from a related party. A related party transaction will not work if the related party receives cash. However, if the related party is also doing an exchange and not receiving cash then it is permitted to receive replacement property from the related party pursuant to PLR 2004-40002.
Who is considered a Related Party?
The definition of related parties is a combination of related parties as defined under IRC section 267(b) and section 707(b). This would include:
- Family members (siblings, spouses, ancestors, and lineal descendants)
- An individual and an entity (corporation, partnership, LLC) 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
- 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