Who Is Considered a Related Party in a 1031 Exchange?
Under Internal Revenue Code Section 1031(f), exchanges between related parties can qualify for tax deferral, but special restrictions apply. A related party can include a spouse, sibling, parent, child, certain trusts, or a business entity with a qualifying ownership relationship.
For example, the rules generally cover certain corporations and partnerships involving more than 50% ownership. The complete definition comes from Sections 267(b) and 707(b)(1). A business partner is not automatically a related party merely because you do business together. See our definition of a related party for additional context.
Being related does not automatically prohibit the exchange. Related-party restrictions are also different from the rules determining who may serve as an independent qualified intermediary (QI).
Does It Matter Whether You Buy, Sell, or Swap With a Related Party?
Yes. The transaction’s structure, including who receives property and who receives cash, can materially change the tax result.
| Transaction | General Treatment |
|---|---|
| Directly swapping investment properties with a relative | May qualify if both parties generally retain the properties received for two years and satisfy the other applicable requirements. |
| Selling relinquished property to a relative and buying from an unrelated seller | May qualify through a properly structured exchange, but the complete transaction and potential anti-abuse issues require review. |
| Buying replacement property from a relative who receives cash | May be disallowed under Section 1031(f)(4), even when an unrelated QI facilitates the transaction. |
The third situation deserves particular attention. Under Revenue Ruling 2002-83, using an unrelated intermediary does not make an otherwise disallowed related-party cash-out transaction qualify. Simply retaining the purchased property for two years does not necessarily correct that problem. Our article on related-party exchange risks examines additional scenarios.
What Is the Two-Year Holding Rule?
For an exchange governed by Section 1031(f), if either party disposes of property received in the exchange within two years after the last exchange transfer, the previously deferred gain or loss generally becomes recognizable in the year of that later disposition.
Exceptions can apply to certain dispositions following death, qualifying involuntary conversions, and transactions where the IRS is satisfied that federal income tax avoidance was not a principal purpose. Periods when a property’s holder has substantially reduced risk of loss may also suspend the two-year clock.
This restriction is not a universal two-year holding requirement for every 1031 exchange. Read our guide to the two-year holding period to understand the distinction.
How Should You Prepare for an Exchange Involving Family?
Hypothetical example: You own a qualifying investment property worth $600,000 with an adjusted tax basis of $350,000. Your sister owns another qualifying investment property worth $600,000. You directly exchange the properties without cash or debt adjustments, assuming all other requirements are satisfied.
Your potential deferred gain is $250,000. If your sister sells the property she received after 14 months, Section 1031(f) generally requires recognition of the previously deferred exchange gain unless a statutory exception applies. Both parties should understand the restrictions before proceeding.
Before closing, take these steps:
- Verify the relationship. Have your tax advisor identify the legal owners and determine whether the related-party definitions apply.
- Trace the transaction. Establish who is selling, who is buying, which properties each party receives, and whether anyone is receiving cash.
- Evaluate holding requirements. Review the expected ownership periods, potential exceptions, and any prearranged resale plans.
- Arrange exchange administration. Engage an independent QI and coordinate the normal identification and closing deadlines. Understand the qualified intermediary’s responsibilities.
- Plan tax reporting. Related-party exchanges generally require Form 8824 for the exchange year and the following two tax years, as explained in the IRS instructions.
A CPA or tax attorney should evaluate whether the specific arrangement qualifies. A qualified intermediary can administer the exchange mechanics but cannot establish tax eligibility or eliminate the related-party restrictions.