1031 Tax Deferred Exchanges:

“An Overview of Several Requirements for Tax Deferral”

INTENT OF THE RELATED PARTY RULES 

The related party rules were enacted to prevent related parties from “cashing out” of an investment and avoiding tax if either party’s property is disposed of within two years of the exchange. In addition, Section 1031(f) states that the Internal Revenue Service reserves the right to invalidate any exchange in which the taxpayer can’t prove that the “exchange” did not have a principal purpose of avoiding taxes  that would otherwise be due or avoiding the purposes of the related party rules. 

WHO IS A RELATED PARTY? 

A related party is any person or entity bearing a relationship with the taxpayer. Although not an exhaustive definition, this includes: 

1. Family members such as brothers, sisters, spouses, ancestors and lineal descendents. (Stepparents, uncles, in-laws, cousins, nephews and ex-spouses are not considered related.) 

2. A corporation or partnership in which more than 50% of the stock or more than 50% of the capital interest is owned by the taxpayer. 

LET’S LOOK AT SEVERAL SCENARIOS 

Allthough it is important to consult with tax or legal advisors before attempting any exchange with a related party, some guidelines exist which are useful in analyzing related party exchanges. 

Simultaneous Exchange 

When related parties directly swap with each other, both parties must hold the property acquired for two years following the exchange. If either party disposes of their property within the two year holding period, then the capital gain tax will need to be recognized. 

Delayed - Selling to a Related Party 

A taxpayer can sell to a related party, but the related party must hold the property for a minimum of two years or the exchange will be invalidated. 

Delayed - Purchasing from a Related Party 

A taxpayer cannot purchase a replacement property from a related party and defer capital gain taxes. In Private Revenue Ruling 9748006, the IRS disallowed  tax deferral to a taxpayer who purchased his mother’s property. 

A reasonable guideline to observe is: “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 may be disallowed.”

                                   ASSET PRESERVATION

                        I N C O P O R A T E D

A National IRC § 1031 “Qualified Intermediary”

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This information is not intended to replace qualified legal and/or tax advisors. Every taxpayer should review their specific transaction with their own legal and/or tax counsel.                                                                                                                � 2000  Asset Preservation, Inc.