1031 exchange:
RELATED PARTY 1031 EXCHANGES FULL OF SUBTLETIES

The IRS defines related parties as parents, spouses, children, agents of the taxpayer or entities where the same individuals control at least fifty percent of both entities.

First:
Section 1031(f)(1) of the Code provides that if a taxpayer exchanges property with a related person, resulting in non-recognition of gain under the section, and within two years of such exchange the related person or the taxpayer disposes of the property received in the exchange, then the taxpayer must recognize the gain. The effective date upon which the taxpayer must recognize the gain will be the date upon which the later sale occurs.
Therefore, when related parties engage in an exchange, both parties must retain the property obtained in the exchange for two years for either of them to achieve the tax deferred advantages of section 1031.
The purpose of this code section is to prevent basis shifting between related parties, for example. Dad owns the Mayfair apartment building with value of $1M and basis of $100K. Son own the Fairoaks apartment building with a value of $1M and a basis of $900K. Dad receives an offer to sell Mayfair. Instead, Dad and Son 1031 exchange Mayfair and Fairoaks. Son then sells Mayfair to buyer. Unless two years had elapsed after the 1031 exchange between Dad and Son both parties would lose their 1031 tax deferral.

Second:
In a three party exchange, where the exchanger sells the old property to a related party and buys the new property from an unrelated party, the old property should be held for two years in order to assure no recognition. The same rational as expressed above applies here. If the related party, now owning the old property, immediately sold the old property they would have no gain recognition. They would, as a practical matter, have accomplished the basis shifting prohibited by section 1031(f). (TAM 9748006)

Third:
In a three party exchange, where the exchanger sells the old property to an unrelated party; the new property usually may NOT be purchased from a related party. The IRS treats purchase from a related person as buying from yourself and disallows tax deferral. If you think of related parties as the same tax payer then buying from a related party does look like buying from yourself. When you buy from yourself you start the exchange with two properties and finish the exchange with one property and cash, no exchange. This cashing out of real estate will disallow the tax deferral. There are two EXCEPTIONS to this rule: a) The related party is also doing a 1031x when he sells to you, (PLR 2004-40002), or b) the gain that he is recognizing is larger than the one you are deferring. (1031)(f)(2)(C). Under exception a) no cashing out occurs, and under except b) tax deferral is not occurring.

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