1031 exchange with related party

[Mary Burns]

I would like to sell a rental property and do a 1031 exchange to buy a property from my mother's estate (I am a beneficiary). I just learned this might be an issue due to related party.

[Bill B.]

I BELIEVE it’s just a sticking point not a prohibited one like it is with self directed Ira’s. I also BELIEVE their biggest concern is tax liability shifting. (Imagine buying a primary home from a relative for $200k more than it’s worth. They take the gain tax free. Then you sell your rental at a $200k loss.). Reach out to @Dave Foster. 

[Mary Burns]

Quote from @Bill B.:

I BELIEVE it’s just a sticking point not a prohibited one like it is with self directed Ira’s. I also BELIEVE their biggest concern is tax liability shifting. (Imagine buying a primary home from a relative for $200k more than it’s worth. They take the gain tax free. Then you sell your rental at a $200k loss.). Reach out to @Dave Foster. 

 Thanks. I keep reading and I am very confused. My mother had 3 rental properties and we plan to sell them. It is a lot of work to fix up and sell so I thought I would buy one from my siblings or her estate. I have a rental property that I would like to sell because it is further away from where I live than I would like. My plan was to sell to the tenants and do a 1031 exchange to buy a duplex from my mother's estate. I paid $200K for the rental property and will sell for about $600K. The remaining mortgage is $27K. The duplex was assessed at $1,575K (in California) but it requires a lot of work. I was planning to pay $1.4 or $1.5 for it. I intend to keep it and rent it. I am not trying to avoid taxes but defer them which I thought was the intent of the 1031 exchange. There will be no gain on the sale of the property for the estate since we got the stepped up basis when she passed. I am okay if I have to pay the taxes but want to make sure I really have to. It seems crazy if I bought from an unrelated party, it would be fine. 

[Bill B.]

Reach out to Dave or another QI. I was going to say…I think you’ll be ok because of the fact the selling related party won’t owe any taxes. BUT. Now that I say that. Do you see how you could pay her estate $300k more than it’s worth. She would still owe no taxes and you would show a $300k loss (or lower gain) when you sold. That’s what they are afraid people would do. 

I BELIEVE you would be ok with a BPO (ask a realtor how much they would list it for.) and an appraisal. If you pay the average of those 2 I think you would be safe. Even though in real life you should be able to buy it for 5% less the estate is saving in real estate commissions. 

If you can’t get Dave or someone else to say (like your CPA) they’re confident you’d be ok. You could always buy an equivalent property from someone else. I still like the idea of you doing a 1031. 

Ps. As far as I know they are weirdly ambivalent about you selling your 1031 exchange to a related party.  Unless that’s change or was never true. 

[Mary Burns]

I will talk to a CPA but just trying to educate myself. I may not understand but I think if I paid more than the assessed value for the property, the estate would owe tax on the gain. Thanks fo the help!

[Dave Foster]

@Bill B. Thanks for that shout out Bill.  @Mary Burns, There is no hard staute prohibiting the purchase of a property from a related party.  But the IRS has stated that it is not appropriate in a 1031 exchange where the is the intent to avoid taxes.  Most folks think that this is referring to a practice called basis shifting which would allow your moms estate to sell property to you at an inflated price in order to take advantage of the tax free step up in the estate.  

But there are some folks who think that simply doing a 1031 exchange is trying to avoid tax (which it is).  And this would make it a prohibited transaction.  

Some accountants feel that you shouldn't buy from a related party in a 1031.  A lot of accountants now say that it is perfectly fine as long as it is documented as an arms length business like transaction.  

I'll be interested to hear where your accountant comes down on the issue.

[Account Closed]

Quote from @Dave Foster:

@Bill B. Thanks for that shout out Bill.  @Mary Burns, There is no hard staute prohibiting the purchase of a property from a related party.  But the IRS has stated that it is not appropriate in a 1031 exchange where the is the intent to avoid taxes.  Most folks think that this is referring to a practice called basis shifting which would allow your moms estate to sell property to you at an inflated price in order to take advantage of the tax free step up in the estate.  

But there are some folks who think that simply doing a 1031 exchange is trying to avoid tax (which it is).  And this would make it a prohibited transaction.  

Some accountants feel that you shouldn't buy from a related party in a 1031.  A lot of accountants now say that it is perfectly fine as long as it is documented as an arms length business like transaction.  

I'll be interested to hear where your accountant comes down on the issue.

 Id be interested to see if they suggest attaching comps for supporting the price the exchange is done at... that seems like a prudent thing to do

[Ashish Acharya]

@Mary Burns
A 1031 exchange with a related party, such as purchasing property from your mother's estate, is allowed under IRS rules but comes with strict conditions. Both you and the related party must hold the properties for at least two years after the exchange.

If either party sells or disposes of the property before the two-year mark, the IRS could disqualify the exchange, making the capital gains immediately taxable. Related parties are defined as family members or entities in which you have more than 50% control.