
In a Section 1031 exchange, no gain or loss is recognized on an exchange of real property that is held for productive use in a trade or business or for investment if...
In a Section 1031 exchange, no gain or loss is recognized on an exchange of real property that is held for productive use in a trade or business or for investment if such real property is exchanged solely for real property that is like kind, which is to be held either for productive use in a trade or business or for investment. Such transactions often occur with unrelated parties, but sometimes Section 1031 exchanges occur with related parties [as defined in Sections 1031(f)(1)(A), 267(b) or 707(b)(1)].
The most talked about part of the related-party rules is the two-year holding period requirement, which applies to both the relinquished property (the property sold to the related party) and the replacement property (the property acquired from the related party). Should a subsequent sale occur by either related parties prior to the satisfaction of the two-year holding period requirement, the original like-kind exchange will not qualify for nonrecognition treatment under Section 1031.
Other interesting items in the related-party rules for Section 1031 exchanges include:
- A disposition prior to the satisfaction of the two-year holding period requirement would not trigger a gain if:
- The disposition was due to death.
- The disposition was the result of an involuntary conversion, as defined by Section 1033.
- The disposition or series of subsequent transactions was not for the sole purpose of tax avoidance. In other words, could the taxpayer prove to the IRS that neither the original like-kind exchange nor the subsequent disposition took place simply to avoid paying tax on the dispositions?
- Should a subsequent transaction invalidate the nonrecognition of gain, that gain would not be recognized until the effective date of the invalidating transaction. So if properly planned, this could be a clever way to defer a potential gain upon disposition.
- If a qualified intermediary is used, the transaction is not viewed as being between related parties; however, if the qualified intermediary is used for the primary purpose of circumventing the aforementioned rules, then tough noogies.
Sources: IRS.gov, RIA Checkpoint.
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