Related Party Rules in §1031 Exchanges: Navigating Complexity for Compliance

The rules sur­round­ing relat­ed par­ties in §1031 exchanges often lead to con­fu­sion and mis­con­cep­tions. While many believe that trans­ac­tions involv­ing relat­ed par­ties are pro­hib­it­ed under the Inter­nal Rev­enue Code (IRC) Sec­tion 1031, excep­tions exist that allow such exchanges under spe­cif­ic con­di­tions.

March 9, 2025

By Al DiNi­co­la, AIF®
DST §1031 Spe­cial­ist
NAMCOA® — Naples Asset Man­age­ment Com­pa­ny®, LLC
Secu­ri­ties offered through MSC-BD, LLC, Mem­ber of FINRA/SIPC

We receive calls from investors sell­ing their busi­ness and the asso­ci­at­ed real estate to a fam­i­ly mem­ber. The investor may be seek­ing to do a §1031 exchange into a Delaware Statu­to­ry Trust (DST) by sell­ing the real estate prop­er­ty to a relat­ed par­ty tak­ing over their busi­ness.   The sell­er wants to move on to a more pas­sive invest­ment for the real estate and poten­tial­ly uti­lize a gain on the busi­ness sale via an Oppor­tu­ni­ty Zone invest­ment. This arti­cle explores the relat­ed par­ty rules, clar­i­fies who qual­i­fies as a relat­ed par­ty, and out­lines the excep­tions and con­sid­er­a­tions investors need to know to nav­i­gate these trans­ac­tions suc­cess­ful­ly.

What Is a Relat­ed Par­ty in a §1031 Exchange?

Under Sec­tions 267(b) and 707(b)(1) of the IRC, a relat­ed par­ty in a §1031 exchange includes:

• Imme­di­ate Fam­i­ly Mem­bers: Sib­lings, spous­es, ances­tors (par­ents, grand­par­ents), and descen­dants (chil­dren, grand­chil­dren).
• Busi­ness Enti­ties with Sig­nif­i­cant Own­er­ship or Con­trol: Enti­ties where the exchang­er holds more than 50% own­er­ship, such as cor­po­ra­tions, part­ner­ships, or trusts; two cor­po­ra­tions that are mem­bers of the same con­trolled group; and cor­po­ra­tions and part­ner­ships with more than 50% direct or indi­rect com­mon own­er­ship.
• Cer­tain Fidu­cia­ry Rela­tion­ships: For exam­ple, an exchang­er and the fidu­cia­ry of a trust.
• Affil­i­at­ed Busi­ness­es: Enti­ties direct­ly or indi­rect­ly con­trolled by the exchang­er or their imme­di­ate fam­i­ly.

This broad def­i­n­i­tion ensures that any trans­ac­tion involv­ing indi­vid­u­als or enti­ties with close per­son­al or finan­cial ties is sub­ject to height­ened IRS scruti­ny to pre­vent abuse.

Why Relat­ed Par­ty Rules Exist

Before 1984, relat­ed par­ty trans­ac­tions in §1031 exchanges were prone to manip­u­la­tion. For exam­ple, relat­ed par­ties could shift tax lia­bil­i­ties or inflate prop­er­ty val­ues, under­min­ing the integri­ty of the tax sys­tem. To address this, the Tax Reform Act of 1984 intro­duced safe­guards, includ­ing the two-year hold­ing peri­od, to ensure that these trans­ac­tions are legit­i­mate and not struc­tured to avoid tax­es.

Key Rules and Excep­tions for Relat­ed Par­ty Exchanges

Direct Exchanges Between Relat­ed Par­ties

When two relat­ed par­ties direct­ly exchange prop­er­ties, both par­ties must hold the exchanged prop­er­ties for at least two years fol­low­ing the trans­ac­tion. If either par­ty dis­pos­es of their prop­er­ty with­in this peri­od, the IRS retroac­tive­ly revokes the tax defer­ral, and the orig­i­nal cap­i­tal gain becomes tax­able in the year of dis­pos­al.

How­ev­er, excep­tions to the two-year hold­ing rule exist, includ­ing:

• Death of a Par­ty: If one par­ty dies with­in the two-year peri­od, the rule is waived.
• Invol­un­tary Dis­po­si­tions: Events like emi­nent domain or nat­ur­al dis­as­ters that force the sale of a prop­er­ty.
• IRS Approval: If the IRS deter­mines the trans­ac­tion was not struc­tured to avoid tax­es.

Sell­ing to a Relat­ed Par­ty

Sell­ing relin­quished prop­er­ty to a relat­ed par­ty in a §1031 exchange is gen­er­al­ly straight­for­ward, as long as the trans­ac­tion com­plies with IRC Sec­tion §1031  guide­lines, includ­ing the require­ment that the prop­er­ty is held for invest­ment or busi­ness pur­pos­es. No spe­cif­ic hold­ing peri­od applies to the relat­ed par­ty acquir­ing the relin­quished prop­er­ty.

Buy­ing from a Relat­ed Par­ty

Pur­chas­ing replace­ment prop­er­ty from a relat­ed par­ty comes with stricter require­ments. The relat­ed par­ty sell­ing the prop­er­ty must also be con­duct­ing a §§1031 exchange for the trans­ac­tion to qual­i­fy. If the relat­ed par­ty is not engag­ing in their own exchange, the trans­ac­tion will like­ly be dis­qual­i­fied.

Doc­u­men­ta­tion and IRS Com­pli­ance

Relat­ed par­ty exchanges are sub­ject to height­ened scruti­ny, mak­ing thor­ough doc­u­men­ta­tion crit­i­cal. Investors should main­tain detailed records, includ­ing:

• Prop­er­ty appraisals
• Con­tracts and exchange agree­ments
• Cor­re­spon­dence with the relat­ed par­ty
• IRS Form 8824, which dis­clos­es the nature of the rela­tion­ship and the trans­ac­tion details

Plan­ning for Suc­cess in Relat­ed Par­ty Exchanges

To nav­i­gate the com­plex­i­ties of relat­ed par­ty rules in §1031 exchanges, con­sid­er the fol­low­ing:

• Under­stand the Two-Year Hold­ing Require­ment: Ensure com­pli­ance with the hold­ing peri­od for direct exchanges to avoid retroac­tive tax con­se­quences.
• Con­sult Pro­fes­sion­als: Work with tax advi­sors, legal pro­fes­sion­als, and a qual­i­fied inter­me­di­ary to ensure the exchange com­plies with all reg­u­la­tions.
• Main­tain Trans­paren­cy: Keep detailed records and file all required forms to demon­strate the legit­i­ma­cy of the trans­ac­tion.

Relat­ed par­ty rules in §1031  exchanges are designed to pro­tect the integri­ty of the tax sys­tem while still allow­ing legit­i­mate trans­ac­tions to occur. By under­stand­ing these rules, plan­ning care­ful­ly, and seek­ing pro­fes­sion­al guid­ance, investors can lever­age §1031 exchanges involv­ing relat­ed par­ties to achieve their invest­ment goals while stay­ing com­pli­ant with IRS reg­u­la­tions.

NAMCOA® is a SEC reg­is­tered invest­ment advi­so­ry firm that pro­vides com­pre­hen­sive port­fo­lio man­age­ment, finan­cial plan­ning, and fidu­cia­ry deci­sion-mak­ing ser­vices on behalf of retire­ment plan spon­sors. Our Dif­fer­ence is sum­ma­rized by our fidu­cia­ry approach which enables us to bet­ter meet port­fo­lio and retire­ment plan objec­tives, result­ing in stronger risk adjust­ed returns for investors and peace of mind for Clients. We also focus on alter­na­tive real estate invest­ment. Many real estate investors are seek­ing tax deferred solu­tions uti­liz­ing §1031 exchanges or Oppor­tu­ni­ty Zones.

DSTs are not for all investors.  The acqui­si­tion of a DST is for accred­it­ed investors only.  Con­tact your invest­ment advis­er for addi­tion­al details on how a DST may be a solu­tion to your §1031 exchange and suit­ed for your invest­ment future. For more infor­ma­tion on how to prop­er­ly set up an IRC §1031 Tax Deferred Exchange or if you are an accred­it­ed investor and would like addi­tion­al infor­ma­tion on a DST con­tact Al DiNi­co­la at 239–691-8098 or email adinicola@namcoa.com.

This is not an offer to pur­chase or solic­i­ta­tion to pur­chase any secu­ri­ty, as such be made only through an offer­ing mem­o­ran­dum or prospec­tus.  Invest­ing in secu­ri­ties, real estate, or any invest­ment, whether pub­lic or pri­vate, involves risk, includ­ing but not lim­it­ed to the poten­tial of los­ing some or all of your invest­ment dol­lars when you invest in secu­ri­ties. You should review any planned finan­cial trans­ac­tions that may have tax or legal impli­ca­tions with your per­son­al tax or legal advi­sor.   NAMCOA, LLC is a Reg­is­tered Invest­ment Advi­sor, reg­u­lat­ed by SEC (Secu­ri­ties and Exchange Com­mis­sion). Our cor­po­rate office is locat­ed at 999 Van­der­bilt Beach Road, Suite 200, Naples Flori­da 34108. Secu­ri­ties Offered through MSC-BD, LLC, Mem­ber of FINRA/SIPC. 5 Cen­ter­pointe Dri­ve, Ste. 400 Lake Oswego, OR, 97035. MSC-BD, LLC and NAMCOA are inde­pen­dent­ly owned and are not affil­i­at­ed.

Thank you.