Questions on 1031 into in-laws property

Andrew Albritton · 2025-02-10T16:04:33-08:00

My in-laws own a 40 acre almond farm in Central Valley, Ca with a 3200 sq. ft. house on it. To make a long story short, they are no longer able to make payments on the property and are in danger of losing it. I have a rental property in Southern California that I currently own whose value if I sell should cover the outstanding loan balance on the farm. My idea is to 1031 the SoCal property into the in-laws farm and rent back to them for a minimum of two years, and then decide if we keep renting it to my in-laws, or move my family into it. I realize I must hold onto the property for at least 5 years. Questions: I assume 1031 exchange is possible as in-laws qualify as an arms length transaction?The property is held in a trust of which both my wife and I are trustees. Does the property need to be removed from the trust and put into my name only? I purchased the property before my wife an I were married and only created the trust after my daughter was born. Up until that point the property was solely in my name.If I decide to occupy the property after 2 years, and decide to sell the property after 5, do I owe the full deferred tax amount, or are the taxes "prorated" based on the ratio of time the property was investment/primary? Thanks in advance

Theresa KnowerBusiness Member

Certified Exchange Specialist · Member since 2024 · 1 post · 1 vote

1y

Hi Andrew,

In response to your questions:

1) If this transaction is a related party transaction, then there are specific rules that must be followed. Purchasing replacement property from a related party is typically prohibited except in very limited circumstances as outlined in I.R.C. § 1031(f)(2)(C). For example, the related party is also completing an exchange. In this instance, all properties involved in the exchange must qualify as an investment (ex. rental) or business-use property.

2) If the property is currently titled in the name of the trust, the trust would technically be the taxpayer/exchanger completing the exchange. The trust would also acquire the new replacement property.

3) If you are renting the property to a related party, please keep in mind that it should be at fair market rental rates. If you eventually convert the property to your primary residence and later sell it, the taxes would be prorated based on the ratio of time the property was investment property.

These items should be addressed and discussed with your tax and legal counsel to ensure that the exchange is the best course of action given the restrictions and requirements.

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Andrew Albritton

OP

Rental Property Investor · Turlock, CA · Member since 2019 · 15 posts · 6 votes

1y

Quote from @Theresa Knower:

Hi Andrew,

In response to your questions:

1) If this transaction is a related party transaction, then there are specific rules that must be followed. Purchasing replacement property from a related party is typically prohibited except in very limited circumstances as outlined in I.R.C. § 1031(f)(2)(C). For example, the related party is also completing an exchange. In this instance, all properties involved in the exchange must qualify as an investment (ex. rental) or business-use property.

2) If the property is currently titled in the name of the trust, the trust would technically be the taxpayer/exchanger completing the exchange. The trust would also acquire the new replacement property.

3) If you are renting the property to a related party, please keep in mind that it should be at fair market rental rates. If you eventually convert the property to your primary residence and later sell it, the taxes would be prorated based on the ratio of time the property was investment property.

These items should be addressed and discussed with your tax and legal counsel to ensure that the exchange is the best course of action given the restrictions and requirements.

Thanks for your response Theresa! I understand I should seek further guidance, I'm just conducting preliminary research to formulate a course of action. A lot of times the different viewpoints lead to different questions to ask.

In regards to your replies:

1) I'm no legal expert, but it seems the sections of tax code you mentioned don't consider in-laws to be a personal relationship that would prohibit the transaction. Is that a reasonable assumption?
2) In regards to the trust, if my wife is a trustee (daughter of the aforementioned in-laws), does that make the transaction no longer "arms length", or does the trust allow the necessary distance to allow the transaction?

3) I am aware that the rent must be market rent, I do wonder if using the 1031 transfer to buy my in-laws property and then immediately renting it back to them would raise any red flags.

Thanks

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Jeff Zimmerman

Real Estate Agent · Fresno, CA · Member since 2014 · 367 posts · 174 votes

1y

hey @Andrew Albritton, sorry that's a tough situation. Best thing to do would be to speak with a good local CPA who can guide you through all of that. I have one in Fresno, Roeser Accountancy that could help with this. I also have a client in Turlock who could rec a good CPA up there as well. Feel free to message me if you'd like to connect with him. Good luck!

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Bill B.

Investor · Las Vegas, NV · Member since 2013 · 8k+ posts · 10k+ votes

1y

Do they not have any equity? Or is your plan to take their equity as your profit? (You said you plan to buy it for the amount of the loan, not the value of the property.). Is so watch out for trip hazzards: if they need government assistance in the future there’s a look back period where the government will want that money. If they are seniors there’s a senior abuse government agency that could get involved. You are converting their tax free gain in to a taxable gain. It’s not an arms length transaction if your wife owns the selling trust that’s buying her parent’s property for less than market value. When it comes time to kick her parents out of their house can they afford to go somewhere else? California is one of the states that will hound you for the proof your 1031 is still valid, only a California expert could say if converting it to your primary would trigger that tax. You’ll lose any property tax caps they may have enjoyed and be increased to the non-owner occupant tax.

If you’re paying market value and they just have zero equity I guess you could argue you’re just giving them two years to move out. But you might be better off just loaning them the money, especially if they are elderly.

Talk to your CPA BEFORE you start the process. Then talk to a qualified, professional QI like @Dave Foster. Good luck.

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Dave FosterBusiness Member

Qualified Intermediary for 1031 Exchanges · St. Petersburg, FL · Member since 2013 · 9k+ posts · 9k+ votes

1y

thanks for that shout out @Bill B.. @Andrew Albritton, Here's some thoughts numbered like your questions.

1. Although in-laws are not related to you, they are related to your wife. And since you hold the property with your wife in a trust that makes this a related party scenario. There is no statutory prohibition against buying from a related party in a 1031 exchange. However there can be no motive of lessening a tax burden. A lot of folks think this means that any 1031 exchange with a related party is forbidden. But a lot of other folks are fine doing them as long as they are strictly arms length. There hasn't been a lot of recent case law to indicate how the IRS is leaning right now. But your accountant is sure to have an opinion.

2. Putting the property into your name only isn't going to help you if that trust is a disregarded entity and you and your wife file a joint tax return. The IRS is concerned with the tax return that is reporting the activity of the property. If the trust is disregarded and you and your wife file a joint tax return the property is reported on your personal joint return. If you quit claim into your name it will still be reported on your joint tax return. Not going to help you with the related party issue.

3. If you convert into your primary residence you still have to recapture all depreciation. But tax on the gain will be prorated. As long as you have owned the property for 5 years. And lived in it for at least 2 out of the 5 years prior to selling. In your example you would get 60% (3/5ths) of the gain tax free.

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Andrew Albritton

OP

Rental Property Investor · Turlock, CA · Member since 2019 · 15 posts · 6 votes

1y

Quote from @Bill B.:

Do they not have any equity? Or is your plan to take their equity as your profit? (You said you plan to buy it for the amount of the loan, not the value of the property.). Is so watch out for trip hazzards: if they need government assistance in the future there’s a look back period where the government will want that money. If they are seniors there’s a senior abuse government agency that could get involved. You are converting their tax free gain in to a taxable gain. It’s not an arms length transaction if your wife owns the selling trust that’s buying her parent’s property for less than market value. When it comes time to kick her parents out of their house can they afford to go somewhere else? California is one of the states that will hound you for the proof your 1031 is still valid, only a California expert could say if converting it to your primary would trigger that tax. You’ll lose any property tax caps they may have enjoyed and be increased to the non-owner occupant tax.

If you’re paying market value and they just have zero equity I guess you could argue you’re just giving them two years to move out. But you might be better off just loaning them the money, especially if they are elderly.

Talk to your CPA BEFORE you start the process. Then talk to a qualified, professional QI like @Dave Foster. Good luck.

Thanks for your response Bill.

My goal is to simply prevent them from losing the farm. I would pay them whatever the sale of my property yields, minus any taxes incurred due to not taking a mortgage out. There are a lot of circumstances that go into the situation, but I promise you I am not trying to take advantage of the situation. I am simply trying to offer a solution that is fair to both parties that allows the property to stay in the family.

The biggest problem is they are having trouble refinancing the property due to credit balances. My MIL owns a floral business and apparently the credit card she uses for her business is keeping her from refinancing. I don't know the whole story there, but it may be worth getting an explanation to figure out solutions

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Ashish AcharyaBusiness Member

CPA, CFP®, PFS · FL · Member since 2017 · 5k+ posts · 3k+ votes

1y

@Andrew Albritton Yes, a 1031 exchange is possible, but since your in-laws are related parties, both you (the buyer) and they (the sellers) must hold onto the exchanged properties for at least two years to comply with IRS rules. Renting the farm to them at fair market value with a formal lease is essential. Please consult with an attorney that is familiar with 1031 exchanges.

If you move into the farm after two years and later sell it, capital gains will be prorated based on investment vs. primary residence use, limiting your Section 121 exclusion ($250K single / $500K married). Depreciation recapture (taxed at 25%) will also apply. In California, transferring ownership could trigger a property tax reassessment,

To maintain compliance, a qualified intermediary (QI) must facilitate the 1031 exchange, and you cannot take direct possession of sale proceeds. Alternatives include seller financing, a lease option, or using an LLC or trust to structure the deal while maintaining tax benefits. Given the related-party rules and tax complexities, consulting a 1031 exchange expert, real estate CPA and attorney is strongly recommended.

This post does not create a CPA-Client relationship. The information contained in this post is not to be relied upon. Readers should seek professional advice.

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