Combining $500K personal exemption & 1031 exchange

[Stacy Tring]

Hi all, 

My relative wants to combine their $500K personal exemption & a 1031 exchange to liquidate their rental properties without paying taxes, but they are worried about missing the180-day time limits for the 1031 exchange, so they want to involve their son-in-law (SIL). My understanding is that in-laws are not considered a related party for the purposes of 1031 exchanges.

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My relative is asking if this is a viable way to legally avoid having to pay taxes:

STEP 1: SELL PRIMARY RESIDENCE (House A)

-Sell primary residence to son-in-law for cost basis + $500K

-File gift tax form for difference between sale price & market value

-Not pay capital gains on $500K due to personal exemption.

STEP 2: SELL RENTAL PROPERTIES

-Do 1031 exchange and buy House A back from son-in-law

-Rent out House A for 1 year before move back in

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Thoughts? What timelines would they need to be aware of? Thanks in advance.

[Natalie Kolodij]

No. There's something called the step doctrine. 

Basically just putting a step in the middle of a disallowed transaction that is really only there with no actual profit/business/clean motive except tax avoidance...is not valid. 

There are several other issues with this; but just know at it's core it's an attempt at tax avoidance-not tax reduction. And it's not valid.