Related Party 1031 Exchanges – Don’t Buy from Mom or Dad!

The 1031 like-kind exchange can seem intimidating for real estate investors and owners. There are often multiple moving parts to coordinate, multiple parties to manage, and many thousands of dollars in tax liability at stake. You can understand why exchangers might want to have a Plan B or Plan C to help them sleep better at night while their 45-day or 180-day clock is ticking.

If asked about a back-up plan, our team at Fortitude recommend the Delaware Statutory Trust (DST) when appropriate and suitable. In certain scenarios, Qualified Opportunity Zone investment may also serve as a fallback.

The DST provides passive, fractional ownership of institutional-quality real estate through the 1031 exchange. A 1031 exchange investment into a DST provides exchangers potential for cash-flow and appreciation, while still allowing them to defer that capital gains tax liability. Perhaps most important, the DST also allows investors the ability to reserve equity in specific deals. They can feel more confident knowing they have that Plan B in case some other deal falls through.

What is a Related Party?

Unfortunately, not everyone performing a 1031 exchange knows about the DST option. Without the DST as a back-up, we see some exchangers try to get creative.

Identifying one of Mom or Dad’s properties as a replacement may seem like a foolproof way to ensure you have at least one property to purchase inside the 180-day window. After all, you have an “in” with the seller, right? The thinking goes that Mom or Dad can then cash out, especially if they’re of an age where they’re eying an exit anyway.

Unfortunately, Mom, Dad, siblings, spouse, and a variety of others are considered “related parties” in the eyes of the IRS (check §267(b) and §707(B) for the full list). There are special rules around transactions with these types of parties, disallowing 1031 tax-deferral benefits “to any exchange which is part of a transaction (or series of transactions) structured to avoid the purposes of this subsection.”

Rules of Related Party Exchanges

Two general rules of thumb to remember when considering related party exchanges:

• Most 1031 exchanges that include the purchase of the replacement property from a related party will result in tax basis swapping and be disallowed, as described by Revenue Ruling 2002-83
• Purchase of replacement property from a related party may be acceptable if the related party is performing their own 1031 exchange

Every 1031 exchange scenario is unique, as is every investor. We always recommend investors consult the appropriate tax and legal advisors when considering a 1031 exchange.

For those investors or exchangers who are seeking replacement property or a Plan B for their 1031 exchange, the DST may be a suitable alternative. Don’t hesitate to reach out and ask about immediate access to our turnkey 1031 replacements properties.

This is for informational purposes only, does not constitute as individual investment advice, and should not be relied upon as tax or legal advice. Please consult the appropriate professional regarding your individual circumstance. Fortitude Investment Group does not offer legal or tax advice.

There are material risks associated with investing in DST properties and real estate securities including liquidity, tenant vacancies, general market conditions and competition, lack of operating history, interest rate risks, the risk of new supply coming to market and softening rental rates, general risks of owning/operating commercial and multifamily properties, short term leases associated with multi-family properties, financing risks, potential adverse tax consequences, general economic risks, development risks, long hold periods, and potential loss of the entire investment principal. Past performance is not a guarantee of future results. Potential cash flow, returns and appreciation are not guaranteed. IRC Section 1031 is a complex tax concept; consult your legal or tax professional regarding the specifics of your particular situation. This is not a solicitation or an offer to sell any securities. DST 1031 properties are only available to accredited investors (typically have a $1 million net worth excluding primary residence or $200,000 income individually/$300,000 jointly of the last three years) and accredited entities only. If you are unsure if you are an accredited investor and/or an accredited entity please verify with your CPA and Attorney.

Securities offered through Concorde Investment Services, LLC (CIS), member FINRA/SIPC. Advisory services through Concorde Asset Management, LLC (CAM), an SEC-registered investment adviser. Insurance offered through Concorde Insurance Agency, Inc. (CIA). Fortitude Investment Group is independent of CIS, CAM and CIA.