Exchange of property between related parties . There is a special rule for exchanges between related parties (IRC §1031(f)) which requires related taxpayers exchanging property with each other to hold the exchanged property for at least two years following the exchange to qualify for non-recognition treatment. If either party disposes of the property received in the exchange before the running of the two-year period, any gain or loss that would have been recognized on the original exchange must be taken into account on the date that the disqualifying disposition occurs.
Sale to an unrelated party, replacement from a related party. A taxpayer will often desire to sell to an unrelated party and receive replacement property from a related party. This type of related party transaction does not work, according to the IRS, if the related party receives cash (Rev. Rul. 2002-83). The IRS reasons that if the taxpayer or a related party "cashes out" of property in this manner, IRC §1031(f)(4) "kicks in" and the exchange is disallowed. However, if the related party is also doing an exchange (and is not "cashing out") then it is okay to receive replacement property from a related party according to PLR 200440002 and PLR 200616005.
Sale to a related party, replacement from an unrelated party. A taxpayer will often sell to a related party but receive replacement property from an unrelated party. This is OK but it has been unclear whether the related party was required to hold the property it acquired from the taxpayer for two years. Instructions to Form 8824 seem to imply that the two-year rule applies. Tax and exchange professionals have generally advised their clients to comply with the two-year rule. However, PLR 200706001, PLR 200712013 and PLR 200728008 released in 2007 say that the two-year rule does not apply to a related party who purchased the relinquished property from the taxpayer.
Related parties under the rules are the following -
A disqualifying disposition does not include dispositions by reason of the death of either party, the compulsory or involuntary conversion of the exchanged property if the exchange occurred before the threat or imminence of the conversion, or dispositions where it is established to the satisfaction of the IRS that neither the exchange nor the disposition had as one of their principal purposes the avoidance of federal income tax.
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