Category: Nontaxable Exchanges; Real Estate
Subject: Section 1031 Exchanges
Title: Related Party Section 1031 Exchange Issues
IRC Sections: 1031
Filename: 1327.html
Date Produced: 06/94

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Taxpayer is an S corporation 51% of the stock of which is owned by an individual and the balance of the stock owned by his children. The S corporation is in the business of operating motels. The S corporation has "sold" (i.e., placed with an accommodator) a motel worth $6.1 million. Taxpayer would like to arrange a like kind exchange. The target property for the exchange is land plus construction in progress owned by the 51% shareholder. The property was acquired approximately 6 months ago. It is anticipated that about $3 million will ultimately be expended on the project inclusive of land costs. The balance of the purchase price will be invested in another motel.

Issue 1:
Does a like kind exchange between the S corporation and its controlling shareholder qualify under Sec 1031? In essence, is there anything that prohibits an otherwise qualified §1031 exchange between related parties?

Issue 2:
Does land plus construction in progress meet the identification requirement? In essence, the project will not be completed within the identification period.

Answer 1:
It is clear that related parties can successfully exchange property under §1031 provided the exchange is qualified under §1031 in all other respects and the holding period requirement of §1031(f) is respected.

Answer 2:
It is clear that real property plus construction in progress meet the identification requirements provided the improvements to be constructed are described in sufficient detail.

Discussion 1:
The issue is whether there is any prohibition against a §1031 exchange between related parties purely by virtue of the fact that the exchanging parties are related. It is clear there is no such prohibition for the following reasons. 1. There is nothing in the statute, regulations, rulings, or case law to suggest there is such a prohibition.

2. The mere existence of §1031(f) is an extremely strong clue that related party exchanges are viable. As you know, §1031(f) requires that property received in an exchange between related parties must be held for at least two years. Otherwise, the §1031 exchange is invalidated. If §1031 were inapplicable to exchanges between related parties, §1031(f) would be moot and would not exist in the first instance. §1031(f) simply adds an additional requirement for §1031 exchanges between related parties.

3. The author of BNA Portfolio 567-1, Tax Free Exchanges Under Section 1031, flatly states that §1031 exchanges are allowed between related parties. Although this is not authoritative, coming from a person who has spent a considerable portion of his professional career dealing with the §1031 area, it provides a good deal of comfort that there is not something relative to this issue that we are missing.

Discussion 2:
The regulations specifically provide that land plus to-be-constructed improvements meet the identification requirements provided all other identification requirements are met and the identification specifies in as much detail as practicable the improvements to be constructed. Regulation 1.1031(k)-1(e)(2)(i). The text of the regulation follows.

(2) Identification of replacement property to be produced. (i) In the case of replacement property that is to be produced, the replacement property must be identified as provided in paragraph (c) of this section (relating to identification of replacement property). For example, if the identified replacement property consists of improved real property where the improvements are to be constructed, the description of the replacement property satisfies the requirements of paragraph (c)(3) of this section (relating to description of replacement property) if a legal description is provided for the underlying land and as much detail is provided regarding construction of the improvements as is practicable at the time the identification is made.