IRC §1031(f) provides that a tax-deferred exchange will be disallowed if the exchanger trades property with a “related prop­erty”, and either party sells one of the exchange properties within two years. The purpose behind the rule is to prevent people from engaging in sham property swaps to shift their cost basis and then cashing out of properties with much lower tax consequences.

Under Revenue Ruling 2002-83, you generally cannot purchase your replacement property from a related party, regardless of the two-year holding period, unless the related party also conducts a §1031 exchange involving the same property. However, you likely can sell your relinquished property to a related party, provided you purchase your replacement property from a legitimate third party. This is admittedly an over-simplification of numerous codes, reg­ulations and court cases. Application of the law may depend on which Circuit Court of Appeals has jurisdiction over your state.

Be careful about being too clever in these situations. Even if you involve additional entities or extra steps in a series of transactions that achieve the same result as a direct related-party exchange, the IRS will apply an “economic substance” test and likely disallow the non-recognition of gain.

For a §1031 exchange, the term “related party” includes your:

  • Full or half-siblings
  • Spouse
  • Ancestors
  • Descendants
  • Business entity of which you own, directly or indirectly, at least 50%

It is possible to have no ulterior motive in transacting with a related party, and still end up having your exchange disallowed. If you are considering buying or selling an exchange property with a relative or business entity of which you own an interest, immediately consult with an experienced tax professional.

The contents herein constitute neither an offer to sell nor a solicitation of an offer to buy any security, which can only be made by prospectus.  Investors should understand all fees associated with a particular investment and how those fees could affect the overall performance of the investment. Neither 1031 Capital Solutions or its representatives, nor DFPG Investments, LLC provide tax or legal advice, as such advice can only be provided by a qualified tax or legal professional, who all investors should consult prior to making any investment decision.