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Related Party Exchanges

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.

Section 1031(f)(4) of the Code adds special rules for transactions between related persons. For purposes of Section 1031(f), the term “related person” means any person bearing a relationship to the Taxpayer described in Section 267(b) or 707(b)(1). Essentially, Section 1031(f) denies tax deferral when related parties perform an exchange of low basis property for high basis property in anticipation of the sale of the high basis property. The rationale for Section 1031(f) is that if a related party exchange is followed shortly thereafter by a disposition of the property, the related parties have essentially “cashed out” of the investment and the original exchange should not receive tax deferred treatment. The IRS tends to look at the related parties as a single economic unit and tax deferred exchange treatment will be disallowed if it is a part of a transaction or series of transactions structured to avoid the purposes of the related party provisions.

- Bill Angove
  Asset Preservation, Inc.
- Keith E. Pershall, Esq.
  Keith E. Pershall, Attorney at Law

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