A Related Party Exchange is a Section 1031 exchange where the purchaser and seller are considered related to each other due to close legal, business or family relationships. Many times clients may wish to acquire or sell to related parties. It is very important that the Qualified Intermediary handling your 1031 exchange not only be an expert but also back up their services with a service guarantee. Most clients do not realize that most Qualified Intermediaries disclaim all responsibility in their agreements, including their own errors.
Since the publication of Revenue Ruling 2002-83, there was some issue whether a related party transaction required both parties to enter into an exchange. I was discussing this very issue with a client a couple of days ago.
PLR 200616005 confirms that where neither related party to the exchange cashes out their investment, that the exchange of like-kind properties between two related parties via a qualified intermediary results in non-recognition treatment under Code Sec. 1031 for each if they hold their respective replacement properties for 2 years.
In Rev Rul 2002-83, one related party exchanged property with another, who in turn received cash from an unrelated party for it. The transaction was structured to allow the related parties to, in effect, sell the property transferred to the third party and receive cash, while minimizing their gain by first transferring it to the related party with a higher basis.
In Private Letter Ruling 200616005, related parties wanted to swap their properties and acquire additional properties from other unrelated parties for cash.
Both the Trust and the S Corp agree that they will not dispose of their respective replacement property within 2 years of the receipt of the replacement property The IRS ruled that neither Trust nor S Corp will recognize any gain realized on their exchange of property if they don't dispose of their respective replacement property (Trust's Building 2, S Corp's Building 3) within 2 years of its receipt.
Non-recognition is permitted because the exchange isn't part of a transaction, or series of transactions, structured to avoid the purposes of Code Sec. 1031(f) and neither party is cashing out of their investment in real estate.