1031 Exchange: Understanding "Related Parties"

The IRS carefully scrutinizes every 1031 exchange. However, when it comes to exchanges between “related parties,” the IRS implements an extra level of restrictions.

Why? The IRS implemented special rules related to “related parties” to combat widespread abuse the IRS believed existed when certain individuals or entities exchanged properties. Specifically, the IRS was trying to mitigate incidents of basis shifting, which gave certain taxpayers an advantage when disposing of property.

But who or what does the IRS consider to be related parties? The definitions may be broader than you expect. Before entering into any 1031 exchange, it is important to fully understand when a “related party” relationship exists. Without this knowledge, your exchange could fail.

26 U.S. Code §267 spells out who qualifies as related parties:

1. Members of a family, including brothers, sisters, half-brothers, half-sisters, spouses, parents, grandparents and other ancestors, as well as children, grandchildren or any other descendants
2. An individual and a corporation more than 50 percent in value of the outstanding stock of which is owned, directly or indirectly, by or for such individual;
3. Two corporations which are members of the same controlled group (as defined in subsection (f));
4. A grantor and a fiduciary of any trust;
5. A fiduciary of a trust and a fiduciary of another trust, if the same person is a grantor of both trusts;
6. A fiduciary of a trust and a beneficiary of such trust;
7. A fiduciary of a trust and a beneficiary of another trust, if the same person is a grantor of both trusts;
8. 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 a person who is a grantor of the trust;
9. A person and an organization to which section 501 (relating to certain educational and charitable organizations which are exempt from tax) applies and which is controlled directly or indirectly by such person or (if such person is an individual) by members of the family of such individual;
10. A corporation and a partnership if the same persons own—
    1. more than 50 percent in value of the outstanding stock of the corporation, and
    2. more than 50 percent of the capital interest, or the profits interest, in the partnership;
11. An S corporation and another S corporation if the same persons own more than 50 percent in value of the outstanding stock of each corporation;
12. An S corporation and a C corporation, if the same persons own more than 50 percent in value of the outstanding stock of each corporation; or
13. Except in the case of a sale or exchange in satisfaction of a pecuniary bequest, an executor of an estate and a beneficiary of such estate.

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