Can You Do a 1031 Exchange With a Relative?

Are you allowed to do a 1031 exchange with a relative? Yes, you are. However, special rules do apply.

Image from firstnationaltitle.net

There is a 2 year test that applies when you perform a 1031 exchange with a related party (a term defined for this context in the Internal Revenue Code). Under this test, if either you or your related party disposes of the property received in the exchange, then the 1031 non-recognition of gain or losses is disallowed.

However, if that occurs the gain or loss would be recognized in the year in which the disposition occurred, not when the exchange took place.

For example, in March 2015 you performed a 1031 exchange with your brother. You traded your brother your Chula Vista rental property for his Escondido rental property. Then, in August 2016 (without your knowledge) your brother sold the Chula Vista property. Even though you had no control over the fact that he sold the property, you did not satisfy the 2 year test so your exchange would be treated as a sale and would be taxable in 2016.

Exceptions

There are 3 exceptions to what otherwise could be a very harsh rule.  These exceptions are:

1. Dispositions that occur after the death of the taxpayer or the related person; 
2. Compulsory or involuntary conversions, if the exchange occurred before the threat or imminence of such conversion; or
3. Dispositions with respect to which it is established to the satisfaction of the Treasury Secretary that neither the exchange nor such disposition had as one of its principal purposes the avoidance of Federal income tax.

If you have questions about 1031 exchanges, please feel free to send me an e-mail.