Can a 1031 Exchange Occur Between Family Members?
The Internal Revenue Code Section 1031, enacted in 1921, allows a seller to defer the tax on gains related to the sale of his investment or business property, provided he reinvests the proceeds in a like-kind property.
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The Facts
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A like-kind exchange can include non-like-kind items, such as cash, relief from debt and other property, but the values of the non-like-kind items are taxed. These types of exchanges allow the property owner to dispose of one property, while acquiring one or more properties that may provide greater appreciation or cash flow.
Reporting Process
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You must report your 1031 exchange on IRS Form 8824 when you file your taxes. Part II of Form 8824 is specifically designated for transactions between related parties. Both parties must hold and report the exchanged property for a minimum of two years.
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Considerations
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There are a few things related parties need to be aware of when considering the 1031 exchange. If the transactions are not completed concurrently, you will be required to use a qualified intermediary to hold the proceeds from the initial sale or forfeit the benefit of the deferred taxes. You must make sure you report the exchange each year during the initial two-year holding period. If either related party sells the property during the two-year holding period, both parties will be taxed on the gains of the exchange transaction. The IRS scrutinizes exchanges between related parties more closely than those between unrelated parties.
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