Related Party Exchanges

How much do you know about the related party rule? The 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. Apiexchange.com reports:

A taxpayer should generally not purchase a replacement property from a related party. In Private Revenue Ruling 9748006, the IRS disallowed tax deferral to a taxpayer who purchased his mother’s property. Revenue Ruling 2002-83 also denied tax deferral treatment to an Exchanger using a Qualified Intermediary to ultimately purchase replacement property from a related party.

Problems Associated With Taking Back Paper

When you sell property and agree to accept a note as part of the purchase price, you may not be able to defer all capital gain taxes when performing a 1031 exchange of the property. That is unless a few scenarios are available. Apiexchange.com reports:

If the investor has the cash available, the investor may buy the note from the QI for its fair market value at the time of the sale of the relinquished property. The sale of the note to the investor occurs during the exchange period, thus allowing the QI to use the note proceeds towards the replacement property purchase. The obstacle with this approach is obviously that the investor must have the cash available to buy the note.