Related Parties
Related parties are defined in IRC 267(b) and 707(b)(1) as persons or entities bearing a relationship to the Exchanger, such as certain members of a family (brothers, sisters, spouse, father, mother, ancestors and lineal descendants).
Buying from a Related Party?
If you are using an intermediary, buying from a related party and selling to an unrelated party, there are very limited instances where you can use a 1031 exchange to defer gain. In most cases, the IRS and courts have disqualified those exchanges because of the potential for basis shifting. The basis shifting can occur and ruin the exchange even when it is unintentional. There have been some rulings which have allowed a taxpayer to buy from a related party provided that the related party was also doing an exchange. In these cases, the related party was buying replacement property in their exchange from an unrelated party.
Exceptions
As discussed above, the related party rules impose a two-year holding period for properties acquired in an exchange, and in some cases prohibit exchanging with a related party. Section 1031(f)(2) contains three exceptions to the limits imposed by 1031(f)(1). First, the parties may dispose of their properties during the two-year holding period upon the death of either the taxpayer or the related party. Second, if either party’s property is subject to an involuntary conversion prior to the end of the two-year period, that disposition will not trigger a taxable event for the parties. Finally, trading with a related party will not disqualify the exchange when “it is established to the satisfaction of the Secretary that neither the exchange nor such disposition had as one of its principal purposes the avoidance of Federal income tax.”
As mentioned above, the non-tax avoidance exception has also been applied to exchanges where the taxpayer is acquiring replacement property from a related party who is also doing an exchange. Finally, the non-tax avoidance exception has been applied to transactions that don’t involve basis shifting or other avoidance of tax, but rulings on this that are favorable to the taxpayer have been very limited.