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1031 Exchanges Involving Related Parties
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The term “related party” as used in Section 1031(f) defines certain close relationships between individuals and other family members, individuals and closely held corporations, partnerships or other legal entities, and certain commonly owned entities that, as a result of such relationship or common control, are subject to special rules designed to prevent the parties from using the tax deferral provided by §1031 to cash out of a business or investment property at a reduced tax. Under these rules, an individual is related to his lineal ancestors, descendants, siblings and spouse, but the application of the related party rules in other contexts can be challenging, especially in cases of legal entities or individuals and legal entities.
In enacting §1031(f), Congress was especially concerned that a taxpayer with a high basis might engage in a tax deferred exchange with a related party in anticipation of a cash sale. Since the seller’s high basis would be switched to the formerly low basis property in the exchange, the formerly low basis property could be sold in a transaction in which a smaller capital gain would result. To prevent this sort of pre-sale basis manipulation, §1031(f) provides that related parties who engage in a tax deferred exchange must continue to hold the properties acquired in the exchange for a period of 2 years after the exchange. If either related party sells a property received in the exchange during the subsequent 2 year period, then both parties must recognize capital gain on the sale unless the parties can establish to the satisfaction of the IRS that neither the exchange nor the subsequent disposition had as one of its principal purposes the avoidance of federal income tax. Convincing the IRS may be very hard to do if there was a disparity in the basis of the assets exchanged. See Teruya Brothers v. Comm.
Given the stakes, careful attention to the related party rules is warranted if the relinquished property or replacement property is transferred to or from a related party. To learn more about related party exchanges, click here and read API’s article Related Party – Caution Needed.
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1031 Basics: What Not to Do In a 1031 Exchange
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Although tax deferred exchanges under Section 1031 have become quite common, most people outside of the exchange industry are not familiar with the legal requirements surrounding a successful tax deferred exchange. Certain strict timelines apply in every 1031 exchange, including: (i) a 45 day “identification period” and (ii) a 180 day exchange period. Each of the foregoing time periods commences on the sale or transfer of relinquished property. Starting then, the taxpayer must deliver a written identification letter to a qualified intermediary or other party to the transaction that describes the property sought to be acquired as replacement property in the exchange. The taxpayer must actually receive the replacement property identified in the exchange no later than the earlier of the 180th calendar day following the transfer of the relinquished property or the due date for the exchanger’s tax return, including extensions. There is a lot more nuance to the rules, but if you want to learn more, click on What Not to Do In a 1031 Exchange.
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1031 Exchange Resources for Foreign Investors
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Are you working with foreign buyers or sellers? Asset Preservation has 1031 exchange information, including translations of the FIRPTA rules, in many languages including Arabic, Chinese Simple, Chinese Traditional, French, German, Italian, Japanese, Portuguese, Russian, Spanish, Thai and Vietnamese. To see some of the 1031 exchange information available, click on §1031 Exchange Resources for Foreign Investors.
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1031 Exchanges and Real Investment Property Solutions Webinar
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Title:Real Investment Property Solutions Date: Wednesday, March 23, 2011 Time: 11:00 a.m. – 12:00 p.m. PST (2:00 p.m. EST) Register Now
Join Scott Saunders, Sr. Vice President of Asset Preservation, along with Mason Hill in a discussion about advanced 1031 exchange strategies and real investment property solutions. Learn about turnkey cash flow real estate with a “time-tested” mathematical model that generates solid investment returns. To reserve your webseat, click on Register Now.
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Asset Preservation, Inc. does not give tax or legal advice. The information contained herein should not be relied upon as a substitute for tax or legal advice obtained from a competent tax and/or legal advisor. If this message was sent to you in error or if you wish to be removed from our email list, please do one of the following: reply to this message, call us toll-free at 866.713.1031, email us at: [email protected] or notify us in writing to: Asset Preservation, Inc., 1420 Rocky Ridge Drive, Suite 100, Roseville, CA, 95661, Attn: Marketing Dept. All rights reserved. 
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