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Everything's
Relative
...except in 1031 exchanges
One
of the trickiest rules to figure when
structuring a 1031 exchange is the rule involving exchanges
between related parties. Can you defer capital gain
taxes with an exchange if you sell a property you own
to a relative? What if you sell your property to a third
party but buy your replacement property from a relative?
What if you and a relative wish to swap properties?
The answer to all these questions is .....sometimes.
The reason for that cop-out answer is because the IRS
is a little unclear about when it will and will not
allow a related party exchange.
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by
Michael Eloranto, Esq.,
Consultant, The 1031 Exchange Experts |
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So,
what is a related party? In IRS terms, a related party
includes certain blood relatives (like siblings and
children), spouses, and business entities you may own,
like corporations or partnerships.
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by Gary Gorman
Founding Partner,
The 1031 Exchange Experts |
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Why
does the IRS care about related parties doing exchanges?
Because for years, clever taxpayers did a lot of what
the IRS calls "basis shifting." Basis shifting occurs
when you want to sell a property with a lot of taxable
capital gain. Instead of just selling it and paying
the taxes, you could use a 1031 exchange to transfer
the gain (or in accounting terms, shift the tax basis)
to another property you own under a different name,
and then sell the formerly high-gain property in your
other name without having to pay the taxes.
The
IRS has issued several rulings in recent years that
make it clear it intends to prevent basis shifting,
starting in 1989 when section 1031 was amended to provide
that related parties could exchange properties, so long
as each party holds the property they end up with for
at least two years after the exchange.
But if you're like 99% of our clients, your encounter
with a related party exchange involves a relative on
only one 'side' of the exchange: you are either looking
to sell your property to a relative, or acquire your
new property from a relative, but not both. In this
case, the rules are a lot more complicated. From a series
of IRS rulings since 1997, the best summary of those
rules is this: you can swap properties with a related
party if both of you hold your new properties for two
years after the exchange. You can sell your property
to a relative and exchange into a property from a third
party if you and the relative abide by the two year
holding period. You may not sell your old property to
a third party and exchange into a new property sold
to you by a relative...unless that relative is also
doing an exchange. And the IRS can still disallow your
exchange if it thinks that your exchange was done with
basis shifting as an objective.
So
after a lot of permutations, the best way to state the
rule is back to what we said back in 1997: if
the buyer and seller are related, and one of the parties
ends up with the property and the other ends up with
the cash, the exchange will be disallowed.
But be warned: there is still a lot of uncertainty and
confusion about related party rules, so don't attempt
this kind of exchange without advice from a Qualified
Intermediary that really understands the current status
of the law about related party exchanges.
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