1031 Exchange Rules

Very often when property is sold and the requirement for replacement property needs to be completed, the seller would prefer to use property already owned as the replacement property. An exchange between related persons can qualify for non-recognition treatment under IRC 1031.

A definition of "Related Persons" is described in IRC 267(b) and IRC 707(b) as follows:

1. Family members (siblings, spouse, ancestors, and lineal descendants)

2. Individual and corporation, where more than 50 percent in value of the stock is owned directly or indirectly by or for such individual

3. Two corporations that are part of the same control group

4. A grantor and a fiduciary of the same trust

5. A fiduciary and beneficiary of the same trust

6. A fiduciary of a trust and the fiduciary or beneficiary of another trust where the same person is the grantor of both trusts

7. A fiduciary of a trust and a corporation more than 50 percent in value of the outstanding stock of which is owned, directly or indirectly, by or for the trust or by or for the grantor of the trust

8. A person and an IRC Section 501 organization if the organization is controlled by that person or that person's family

9. A corporation and a partnership if the same persons own more than 50 percent in value of the outstanding stock of the corporation and more than 50 percent of capital interest or profits interest in the partnership

10.An S Corporation and another S Corporation or a C Corporation if the same person own more than 50 percent of the value of the outstanding stock of each corporation

11.A partnership and a person owning, directly or indirectly, more than 50 percent of the capital interest, or profits interest, in such partnership

12.Two partnerships in which the same persons own, directly or indirectly, more than 50 percent capital interests or profits interests

13.An executor of an estate and the beneficiaries of the estate

If property is exchanged with a related person, and the property is disposed of by the related person or the taxpayer of the property, either one received in the exchange within two years of the date of transfer, the gain or loss must be reported.

The two-year holding period is critical in order to sustain the taxdeferred exchange. There are certain exceptions to the two-year holding period, but they are too numerous to discuss for the purposes of this article.

The Internal Revenue Service ("IRS") will carefully scrutinize related party transactions to identify tax avoidance schemes. If the related party transaction is an "arms length" exchange and tax avoidance is not the motive, the related party exchange should work.

1031 Tax |