New IRS ruling relating to related parties...

The IRS recently issued a ruling concerning related-party 1031 exchanges (PLR 200728008). This transaction occurs when a 1031 exchanger either sells to or buys from a family member or his business entity. The most conservative approach is to ensure that both the exchanger and the related-party both end up with property, and neither ends up with cash.

The new Ruling concerned a 1031 exchange where the exchanger sold their Old Property to a related business entity, and the entity did NOT hold the property for two-years. Surprisingly, the IRS did not disallow the exchange, despite earlier IRS authority to the contrary!

The main rationale for this was the IRS could find no scheme to avoid paying taxes. Section 1031 says a related-party exchange will not fall under the related-party rules where “it is established to the satisfaction of the [IRS] that neither the exchange nor such disposition had as one if it’s principal purposes the avoidance of Federal income tax.” [I.R.C. §1031(f)(2)].

So, where does this leave us?

First, this was only a Private Letter Ruling, so it’s low on the “totem-pole” of authority. Second, it is still advisable for both related-parties to hold their respective properties for at least two years. Third, if the properties are not held for two years, be prepared to prove that you were not just trying to avoid taxes.

This is a very complicated aspect of 1031 exchanges. If you are contemplating a related-party exchange, you should consult with a 1031 Exchange Expert.