Category: Rules and Regulations

The IRS Private Letter Ruling (PLR) 202416012 issued on April 19, 2024, addresses the potential issues in a 1031 Exchange of a trust beneficiary’s Tenancy in Common (TIC) interest in an asset that had formerly been owned by the trust. This PLR involves a testamentary Trust (a trust established by the will of a deceased person) that continued to hold property long after the death of the creator of the Trust to presumably assure the Trust property would devolve to specific beneficiaries. When it became apparent the conditions for termination of the Trust had occurred, the trustees of the Trust petitioned the probate court to approve the sale of the Trust real property.   
As part of the termination of the Trust, the Trustees initially considered the sale by the Trust and a 1031 exchange into replacement property. However, certain beneficiaries, including the beneficiary Exchanger requesting the PLR, advised the Trustees and the probate court they wished to effect individual 1031 exchanges of their respective TIC interests in the real property into what would be their individual Replacement Properties. The Trustees and exchanging Beneficiaries, including the Exchanger, agreed as part of the Trust Termination Plan to distribute tenancy in common (TIC) interests in the trust property to separate single member LLCs created by each of the exchanging beneficiaries. Upon approval of the Termination Plan by the Probate Court, each of the LLC’s will complete 1031 exchanges of their TIC interests into Replacement Property.    
The IRS ruled that the distribution from the Trust to Exchanger of the TIC interest will not preclude such interest from being deemed “held for investment or for productive use in a trade or business” within the meaning of § 1031(a) of the Code. In issuing the PLR, the IRS distinguished this transaction from similar transactions described in Rev. Rul. 75-292, 1975-2 C.B. 333 and Rev. Rul. 77-337, 1977-2 C.B. 305 where the IRS ruled that distributions of real property out of a business entity with a short-term hold disqualified the real property as being held for investment/business use. The IRS distinguished those scenarios due in large part to the fact that the distributions were voluntary and pre-planned.   
The facts provided in this PLR which seem to favor the Exchanger are as follows: 

The Trust was a testamentary trust subject to a predetermined termination event beyond the control of the exchanging beneficiaries. 

The holding period by the Trust was very lengthy. 

The Trust always held the subject property for investment/business use. 

The Termination Plan was part of a court-ordered disposition. 

The Exchanger/beneficiary is going to acquire and hold qualifying like-kind property and therefore there is a continuity of investment. 

The Exchanger’s LLC is a Single Member LLC and therefore a disregarded entity. 

We’re left with the question of whether this PLR is a harbinger of a softer stance by the IRS in the area of “drop and swap” transactions incident to a 1031 Exchange. Keep in mind that private letter rulings are not the same as a legal precedent and any reliance is only warranted by the Exchanger seeking the ruling and compliance with the facts set forth in the ruling. Though this ruling may not constitute carte blanche approval of “Drops and Swaps”, it may provide comfort for those Exchangers involved in involuntary distributions which otherwise comport with a substantial amount of the facts in this PLR.   
 
The material in this blog is presented for informational purposes only. The information presented is not investment, legal, tax or compliance advice. Accruit performs the duties of a Qualified Intermediary, and as such does not offer or sell investments or provide investment, legal, or tax advice.  

The IRS Private Letter Ruling (PLR) 202416012 issued on April 19, 2024, addresses the potential issues in a 1031 Exchange of a trust beneficiary’s Tenancy in Common (TIC) interest in an asset that had formerly been owned by the trust. This PLR involves a testamentary Trust (a trust established by the will of a deceased person) that continued to hold property long after the death of the creator of the Trust to presumably assure the Trust property would devolve to specific beneficiaries. When it became apparent the conditions for termination of the Trust had occurred, the trustees of the Trust petitioned the probate court to approve the sale of the Trust real property.   
As part of the termination of the Trust, the Trustees initially considered the sale by the Trust and a 1031 exchange into replacement property. However, certain beneficiaries, including the beneficiary Exchanger requesting the PLR, advised the Trustees and the probate court they wished to effect individual 1031 exchanges of their respective TIC interests in the real property into what would be their individual Replacement Properties. The Trustees and exchanging Beneficiaries, including the Exchanger, agreed as part of the Trust Termination Plan to distribute tenancy in common (TIC) interests in the trust property to separate single member LLCs created by each of the exchanging beneficiaries. Upon approval of the Termination Plan by the Probate Court, each of the LLC’s will complete 1031 exchanges of their TIC interests into Replacement Property.    
The IRS ruled that the distribution from the Trust to Exchanger of the TIC interest will not preclude such interest from being deemed “held for investment or for productive use in a trade or business” within the meaning of § 1031(a) of the Code. In issuing the PLR, the IRS distinguished this transaction from similar transactions described in Rev. Rul. 75-292, 1975-2 C.B. 333 and Rev. Rul. 77-337, 1977-2 C.B. 305 where the IRS ruled that distributions of real property out of a business entity with a short-term hold disqualified the real property as being held for investment/business use. The IRS distinguished those scenarios due in large part to the fact that the distributions were voluntary and pre-planned.   
The facts provided in this PLR which seem to favor the Exchanger are as follows: 

The Trust was a testamentary trust subject to a predetermined termination event beyond the control of the exchanging beneficiaries. 

The holding period by the Trust was very lengthy. 

The Trust always held the subject property for investment/business use. 

The Termination Plan was part of a court-ordered disposition. 

The Exchanger/beneficiary is going to acquire and hold qualifying like-kind property and therefore there is a continuity of investment. 

The Exchanger’s LLC is a Single Member LLC and therefore a disregarded entity. 

We’re left with the question of whether this PLR is a harbinger of a softer stance by the IRS in the area of “drop and swap” transactions incident to a 1031 Exchange. Keep in mind that private letter rulings are not the same as a legal precedent and any reliance is only warranted by the Exchanger seeking the ruling and compliance with the facts set forth in the ruling. Though this ruling may not constitute carte blanche approval of “Drops and Swaps”, it may provide comfort for those Exchangers involved in involuntary distributions which otherwise comport with a substantial amount of the facts in this PLR.   
 
The material in this blog is presented for informational purposes only. The information presented is not investment, legal, tax or compliance advice. Accruit performs the duties of a Qualified Intermediary, and as such does not offer or sell investments or provide investment, legal, or tax advice.  

Real estate investors understand the importance of strategic decisions to enhance their portfolios and maximize returns, but the owner of one business property or family-owned land might not be as familiar with these practices. One powerful tool at a property owner’ s disposal is a 1031 exchange, a provision in the Internal Revenue Code that allows you to defer capital gains taxes, depreciation recapture, state tax, and net investment income tax when selling an investment or business property and reinvesting the proceeds into qualified replacement property. In this article, we’ll look at different scenarios of selling a property held for investment or business use and utilizing a 1031 exchange to reinvest in various property asset classes, including a rental house, an industrial warehouse, and a Delaware Statutory Trust (DST). 
Understanding a 1031 Exchange 
Before we dive into the specifics of each asset class, it’s crucial to understand the fundamentals of a 1031 exchange. This tax deferral strategy enables investors to defer taxes that would otherwise be associated with the sale of the property, by reinvesting the sale proceeds into qualified replacement property within a specified time frame. To qualify for a 1031 exchange, the Relinquished Property and the Replacement Property must both be held for productive use in a trade or business or for investment and held by the same tax entity. 
Key Requirements for a 1031 Exchange: 
Like-Kind Property: The Replacement Property must be of like-kind to the Relinquished Property, but this does not necessarily mean identical. For example, you can exchange a commercial property for a residential property. For purposes of a 1031 exchange, all business or investment property is like-kind. 
Identification Period: Within 45 days of selling the Relinquished Property, you must identify potential Replacement Property(ies) in writing, following one of the three available https://www.accruit.com/blog/what-are-rules-identification-and-receipt-… rules.
Closing Period: The Replacement Property must be acquired, and the exchange completed, within 180 days from the sale of the Relinquished Property. 
Now, let’s explore the potential of reinvesting in different asset classes as Replacement Property in a 1031 exchange. 
Potential 1031 Exchange Reinvestment Scenarios 
Before we dive into examples of reinvestment options through a 1031 Exchange, let’s look at investment scenarios that do not involve a 1031 Exchange.  
Let’s assume a property owner inherited family land and has personally owned, or held, the land for 20 years. Due to urban expansion, the property owner has been offered $2 million by a developer to sell the land. The value of land when inherited was $1.2 million, so upon the sale of land, roughly $230,000 would be owed in Capital Gains Tax, State Tax, and Net Investment Income Tax without a 1031 Exchange. The property owner has reinvestment options that do not involve like-kind property. Some of the most common avenues include, stocks and bonds, mutual funds, and Exchange-Traded Funds (ETFs).  
Let’s look at the estimated annual returns for each of these avenues. Note, the total reinvestment into these avenues is roughly $1,770,000 due to the taxable event without a 1031 Exchange.  
 
Stocks and Bonds: 
Average Return: Stocks historically yield an average annual return of 7-10%, while bonds offer a more conservative but stable return ranging from 2-5%. 
Total Annual Return: Based on the above averages total annual returns could be expected from $35,400-$177,000 annually. 
 
Mutual Funds: 
Average Return: Historical average annual returns for mutual funds typically range between 5-8%. 
Total Annual Return: Based on the above averages total annual returns could be expected from $88,500-$141,600 annually. 
 
Exchange-Traded Funds (ETFs): 
Average Return: Historical average annual returns for well-diversified ETF portfolios tend to align with stock market performance, around 7-10%. 
Total Annual Return: Based on the above averages total annual returns could be expected from $123,900-$177,000 annually. 
 
Potential 1031 Exchange Reinvestment Scenarios 
Now, let’s explore the potential returns of reinvesting in different asset classes as Replacement Property in a 1031 Exchange. By utilizing a 1031 Exchange for the real estate transaction the reinvestment requirement for full tax deferral is the $2 million sale price.  
Rental House Investment: 
One of the most common choices for investors utilizing a 1031 exchange is the acquisition of a rental house. Residential real estate offers stability, potential for appreciation, and a consistent income stream through rental payments. 
Potential Annual Returns: 
Appreciation: Historically, residential real estate has shown steady appreciation. On average, the annual appreciation rate for single-family homes in the United States has hovered around 3-5%. 
Rental Income: The rental market’s performance varies by location, but a well-chosen property in a desirable area can provide a steady rental income. A conservative estimate for annual rental yield is between 4-6% of the property’s value. 
Total Annual Return: Based on the above averages for Appreciation and Rental income, a total between 7% – 11% annual returns could be expected, equating to $140,000-$220,000 annually. 
Tax Benefits: Besides deferring capital gains taxes, rental property owners can benefit from tax deductions, such as depreciation, mortgage interest, property taxes, and operating expenses. 

Industrial Warehouse: 
Investing in industrial real estate, particularly storage warehouses, offers unique advantages. The growing demand for e-commerce and logistics has increased the appeal of this asset class, providing investors with the potential for both appreciation and robust rental income. 
Potential Annual Returns: 
Appreciation: Industrial real estate has witnessed strong appreciation in recent years due to the increasing reliance on online shopping and the need for efficient logistics. Annual appreciation rates can range from 6-8%. 
Rental Income: Industrial storage warehouses can generate substantial rental income, especially in prime locations. Rental yields may range from 6-8%, depending on the specific market and property characteristics. 
Total Annual Return: Based on the above averages for Appreciation and Rental income, a total between 12% – 16% annual returns could be expected, equating to $240,000-$320,000 annually. 
Long-Term Leases: Industrial tenants often sign long-term leases, providing stability and a consistent cash flow for investors. 
Tax Benefits: Similar to a rental home, an industrial warehouse would also provide benefits from tax deductions, such as depreciation, mortgage interest, property taxes, and operating expenses. 
 
Delaware Statutory Trust (DST): 
For investors seeking a passive approach to real estate ownership, Delaware Statutory Trusts (DSTs) offer an intriguing option. A DST is a legal entity that holds title to real estate assets, allowing investors to own a fractional interest in a larger, higher quality property than they could purchase on their own, without the day-to-day management responsibilities. 
Potential Annual Returns: 
Appreciation: Historically, institutional-grade properties including apartment complexes, retail centers, and commercial buildings of properties have shown average annual appreciation rates ranging from 3% to 5% in stable markets over the long term.  
Annual Return: DSTs typically focus on income-producing properties, such as apartment complexes, commercial buildings, or retail centers. Investors on average can expect between a 4-9% annual rate of return.  
Total Annual Return: Based on the above averages for Appreciation and annual return income, a total between 7% – 14% annual returns could be expected, equating to $140,000-$280,000 annually. 
Tax Benefits: DST investors generally receive an annual statement from the Sponsor allocating the investors share of depreciation, mortgage interest, property taxes, and other tax benefits. 
Diversification: DSTs provide diversification by allowing investors to own a portion of multiple properties within a single investment. This diversification can mitigate risks associated with a single property or market. 

1031 Exchanges Impact on Return on Investment 
In conclusion, utilizing a 1031 Exchange to transition from one property to another is a strategic move for property owners or investors looking to optimize their real estate investments. By carefully considering the potential returns and characteristics of traditional investments compared to like-kind real estate investments, investors can increase their reinvestment and tailor their real estate investments to align with their financial goals and risk tolerance. 
Before embarking on a 1031 Exchange, it is crucial to consult with tax professionals, legal advisors, and real estate experts to ensure compliance with regulations and to make informed decisions. Additionally, market conditions and investment landscapes can change, so staying informed about current trends and conducting thorough due diligence is essential for long-term success in real estate investing. 
A well-executed 1031 Exchange can not only defer four levels of tax but also serve as a catalyst for diversification, capital growth, and enhanced income streams within a carefully curated real estate portfolio. 
 
The material in this blog is presented for informational purposes only. The information presented is not investment, legal, tax or compliance advice. Accruit performs the duties of a Qualified Intermediary, and as such does not offer or sell investments or provide investment, legal, or tax advice. 

Real estate investors understand the importance of strategic decisions to enhance their portfolios and maximize returns, but the owner of one business property or family-owned land might not be as familiar with these practices. One powerful tool at a property owner’ s disposal is a 1031 exchange, a provision in the Internal Revenue Code that allows you to defer capital gains taxes, depreciation recapture, state tax, and net investment income tax when selling an investment or business property and reinvesting the proceeds into qualified replacement property. In this article, we’ll look at different scenarios of selling a property held for investment or business use and utilizing a 1031 exchange to reinvest in various property asset classes, including a rental house, an industrial warehouse, and a Delaware Statutory Trust (DST). 
Understanding a 1031 Exchange 
Before we dive into the specifics of each asset class, it’s crucial to understand the fundamentals of a 1031 exchange. This tax deferral strategy enables investors to defer taxes that would otherwise be associated with the sale of the property, by reinvesting the sale proceeds into qualified replacement property within a specified time frame. To qualify for a 1031 exchange, the Relinquished Property and the Replacement Property must both be held for productive use in a trade or business or for investment and held by the same tax entity. 
Key Requirements for a 1031 Exchange: 
Like-Kind Property: The Replacement Property must be of like-kind to the Relinquished Property, but this does not necessarily mean identical. For example, you can exchange a commercial property for a residential property. For purposes of a 1031 exchange, all business or investment property is like-kind. 
Identification Period: Within 45 days of selling the Relinquished Property, you must identify potential Replacement Property(ies) in writing, following one of the three available https://www.accruit.com/blog/what-are-rules-identification-and-receipt-… rules.
Closing Period: The Replacement Property must be acquired, and the exchange completed, within 180 days from the sale of the Relinquished Property. 
Now, let’s explore the potential of reinvesting in different asset classes as Replacement Property in a 1031 exchange. 
Potential 1031 Exchange Reinvestment Scenarios 
Before we dive into examples of reinvestment options through a 1031 Exchange, let’s look at investment scenarios that do not involve a 1031 Exchange.  
Let’s assume a property owner inherited family land and has personally owned, or held, the land for 20 years. Due to urban expansion, the property owner has been offered $2 million by a developer to sell the land. The value of land when inherited was $1.2 million, so upon the sale of land, roughly $230,000 would be owed in Capital Gains Tax, State Tax, and Net Investment Income Tax without a 1031 Exchange. The property owner has reinvestment options that do not involve like-kind property. Some of the most common avenues include, stocks and bonds, mutual funds, and Exchange-Traded Funds (ETFs).  
Let’s look at the estimated annual returns for each of these avenues. Note, the total reinvestment into these avenues is roughly $1,770,000 due to the taxable event without a 1031 Exchange.  
 
Stocks and Bonds: 
Average Return: Stocks historically yield an average annual return of 7-10%, while bonds offer a more conservative but stable return ranging from 2-5%. 
Total Annual Return: Based on the above averages total annual returns could be expected from $35,400-$177,000 annually. 
 
Mutual Funds: 
Average Return: Historical average annual returns for mutual funds typically range between 5-8%. 
Total Annual Return: Based on the above averages total annual returns could be expected from $88,500-$141,600 annually. 
 
Exchange-Traded Funds (ETFs): 
Average Return: Historical average annual returns for well-diversified ETF portfolios tend to align with stock market performance, around 7-10%. 
Total Annual Return: Based on the above averages total annual returns could be expected from $123,900-$177,000 annually. 
 
Potential 1031 Exchange Reinvestment Scenarios 
Now, let’s explore the potential returns of reinvesting in different asset classes as Replacement Property in a 1031 Exchange. By utilizing a 1031 Exchange for the real estate transaction the reinvestment requirement for full tax deferral is the $2 million sale price.  
Rental House Investment: 
One of the most common choices for investors utilizing a 1031 exchange is the acquisition of a rental house. Residential real estate offers stability, potential for appreciation, and a consistent income stream through rental payments. 
Potential Annual Returns: 
Appreciation: Historically, residential real estate has shown steady appreciation. On average, the annual appreciation rate for single-family homes in the United States has hovered around 3-5%. 
Rental Income: The rental market’s performance varies by location, but a well-chosen property in a desirable area can provide a steady rental income. A conservative estimate for annual rental yield is between 4-6% of the property’s value. 
Total Annual Return: Based on the above averages for Appreciation and Rental income, a total between 7% – 11% annual returns could be expected, equating to $140,000-$220,000 annually. 
Tax Benefits: Besides deferring capital gains taxes, rental property owners can benefit from tax deductions, such as depreciation, mortgage interest, property taxes, and operating expenses. 

Industrial Warehouse: 
Investing in industrial real estate, particularly storage warehouses, offers unique advantages. The growing demand for e-commerce and logistics has increased the appeal of this asset class, providing investors with the potential for both appreciation and robust rental income. 
Potential Annual Returns: 
Appreciation: Industrial real estate has witnessed strong appreciation in recent years due to the increasing reliance on online shopping and the need for efficient logistics. Annual appreciation rates can range from 6-8%. 
Rental Income: Industrial storage warehouses can generate substantial rental income, especially in prime locations. Rental yields may range from 6-8%, depending on the specific market and property characteristics. 
Total Annual Return: Based on the above averages for Appreciation and Rental income, a total between 12% – 16% annual returns could be expected, equating to $240,000-$320,000 annually. 
Long-Term Leases: Industrial tenants often sign long-term leases, providing stability and a consistent cash flow for investors. 
Tax Benefits: Similar to a rental home, an industrial warehouse would also provide benefits from tax deductions, such as depreciation, mortgage interest, property taxes, and operating expenses. 
 
Delaware Statutory Trust (DST): 
For investors seeking a passive approach to real estate ownership, Delaware Statutory Trusts (DSTs) offer an intriguing option. A DST is a legal entity that holds title to real estate assets, allowing investors to own a fractional interest in a larger, higher quality property than they could purchase on their own, without the day-to-day management responsibilities. 
Potential Annual Returns: 
Appreciation: Historically, institutional-grade properties including apartment complexes, retail centers, and commercial buildings of properties have shown average annual appreciation rates ranging from 3% to 5% in stable markets over the long term.  
Annual Return: DSTs typically focus on income-producing properties, such as apartment complexes, commercial buildings, or retail centers. Investors on average can expect between a 4-9% annual rate of return.  
Total Annual Return: Based on the above averages for Appreciation and annual return income, a total between 7% – 14% annual returns could be expected, equating to $140,000-$280,000 annually. 
Tax Benefits: DST investors generally receive an annual statement from the Sponsor allocating the investors share of depreciation, mortgage interest, property taxes, and other tax benefits. 
Diversification: DSTs provide diversification by allowing investors to own a portion of multiple properties within a single investment. This diversification can mitigate risks associated with a single property or market. 

1031 Exchanges Impact on Return on Investment 
In conclusion, utilizing a 1031 Exchange to transition from one property to another is a strategic move for property owners or investors looking to optimize their real estate investments. By carefully considering the potential returns and characteristics of traditional investments compared to like-kind real estate investments, investors can increase their reinvestment and tailor their real estate investments to align with their financial goals and risk tolerance. 
Before embarking on a 1031 Exchange, it is crucial to consult with tax professionals, legal advisors, and real estate experts to ensure compliance with regulations and to make informed decisions. Additionally, market conditions and investment landscapes can change, so staying informed about current trends and conducting thorough due diligence is essential for long-term success in real estate investing. 
A well-executed 1031 Exchange can not only defer four levels of tax but also serve as a catalyst for diversification, capital growth, and enhanced income streams within a carefully curated real estate portfolio. 
 
The material in this blog is presented for informational purposes only. The information presented is not investment, legal, tax or compliance advice. Accruit performs the duties of a Qualified Intermediary, and as such does not offer or sell investments or provide investment, legal, or tax advice. 

Real estate investors understand the importance of strategic decisions to enhance their portfolios and maximize returns, but the owner of one business property or family-owned land might not be as familiar with these practices. One powerful tool at a property owner’ s disposal is a 1031 exchange, a provision in the Internal Revenue Code that allows you to defer capital gains taxes, depreciation recapture, state tax, and net investment income tax when selling an investment or business property and reinvesting the proceeds into qualified replacement property. In this article, we’ll look at different scenarios of selling a property held for investment or business use and utilizing a 1031 exchange to reinvest in various property asset classes, including a rental house, an industrial warehouse, and a Delaware Statutory Trust (DST). 
Understanding a 1031 Exchange 
Before we dive into the specifics of each asset class, it’s crucial to understand the fundamentals of a 1031 exchange. This tax deferral strategy enables investors to defer taxes that would otherwise be associated with the sale of the property, by reinvesting the sale proceeds into qualified replacement property within a specified time frame. To qualify for a 1031 exchange, the Relinquished Property and the Replacement Property must both be held for productive use in a trade or business or for investment and held by the same tax entity. 
Key Requirements for a 1031 Exchange: 
Like-Kind Property: The Replacement Property must be of like-kind to the Relinquished Property, but this does not necessarily mean identical. For example, you can exchange a commercial property for a residential property. For purposes of a 1031 exchange, all business or investment property is like-kind. 
Identification Period: Within 45 days of selling the Relinquished Property, you must identify potential Replacement Property(ies) in writing, following one of the three available https://www.accruit.com/blog/what-are-rules-identification-and-receipt-… rules.
Closing Period: The Replacement Property must be acquired, and the exchange completed, within 180 days from the sale of the Relinquished Property. 
Now, let’s explore the potential of reinvesting in different asset classes as Replacement Property in a 1031 exchange. 
Potential 1031 Exchange Reinvestment Scenarios 
Before we dive into examples of reinvestment options through a 1031 Exchange, let’s look at investment scenarios that do not involve a 1031 Exchange.  
Let’s assume a property owner inherited family land and has personally owned, or held, the land for 20 years. Due to urban expansion, the property owner has been offered $2 million by a developer to sell the land. The value of land when inherited was $1.2 million, so upon the sale of land, roughly $230,000 would be owed in Capital Gains Tax, State Tax, and Net Investment Income Tax without a 1031 Exchange. The property owner has reinvestment options that do not involve like-kind property. Some of the most common avenues include, stocks and bonds, mutual funds, and Exchange-Traded Funds (ETFs).  
Let’s look at the estimated annual returns for each of these avenues. Note, the total reinvestment into these avenues is roughly $1,770,000 due to the taxable event without a 1031 Exchange.  
 
Stocks and Bonds: 
Average Return: Stocks historically yield an average annual return of 7-10%, while bonds offer a more conservative but stable return ranging from 2-5%. 
Total Annual Return: Based on the above averages total annual returns could be expected from $35,400-$177,000 annually. 
 
Mutual Funds: 
Average Return: Historical average annual returns for mutual funds typically range between 5-8%. 
Total Annual Return: Based on the above averages total annual returns could be expected from $88,500-$141,600 annually. 
 
Exchange-Traded Funds (ETFs): 
Average Return: Historical average annual returns for well-diversified ETF portfolios tend to align with stock market performance, around 7-10%. 
Total Annual Return: Based on the above averages total annual returns could be expected from $123,900-$177,000 annually. 
 
Potential 1031 Exchange Reinvestment Scenarios 
Now, let’s explore the potential returns of reinvesting in different asset classes as Replacement Property in a 1031 Exchange. By utilizing a 1031 Exchange for the real estate transaction the reinvestment requirement for full tax deferral is the $2 million sale price.  
Rental House Investment: 
One of the most common choices for investors utilizing a 1031 exchange is the acquisition of a rental house. Residential real estate offers stability, potential for appreciation, and a consistent income stream through rental payments. 
Potential Annual Returns: 
Appreciation: Historically, residential real estate has shown steady appreciation. On average, the annual appreciation rate for single-family homes in the United States has hovered around 3-5%. 
Rental Income: The rental market’s performance varies by location, but a well-chosen property in a desirable area can provide a steady rental income. A conservative estimate for annual rental yield is between 4-6% of the property’s value. 
Total Annual Return: Based on the above averages for Appreciation and Rental income, a total between 7% – 11% annual returns could be expected, equating to $140,000-$220,000 annually. 
Tax Benefits: Besides deferring capital gains taxes, rental property owners can benefit from tax deductions, such as depreciation, mortgage interest, property taxes, and operating expenses. 

Industrial Warehouse: 
Investing in industrial real estate, particularly storage warehouses, offers unique advantages. The growing demand for e-commerce and logistics has increased the appeal of this asset class, providing investors with the potential for both appreciation and robust rental income. 
Potential Annual Returns: 
Appreciation: Industrial real estate has witnessed strong appreciation in recent years due to the increasing reliance on online shopping and the need for efficient logistics. Annual appreciation rates can range from 6-8%. 
Rental Income: Industrial storage warehouses can generate substantial rental income, especially in prime locations. Rental yields may range from 6-8%, depending on the specific market and property characteristics. 
Total Annual Return: Based on the above averages for Appreciation and Rental income, a total between 12% – 16% annual returns could be expected, equating to $240,000-$320,000 annually. 
Long-Term Leases: Industrial tenants often sign long-term leases, providing stability and a consistent cash flow for investors. 
Tax Benefits: Similar to a rental home, an industrial warehouse would also provide benefits from tax deductions, such as depreciation, mortgage interest, property taxes, and operating expenses. 
 
Delaware Statutory Trust (DST): 
For investors seeking a passive approach to real estate ownership, Delaware Statutory Trusts (DSTs) offer an intriguing option. A DST is a legal entity that holds title to real estate assets, allowing investors to own a fractional interest in a larger, higher quality property than they could purchase on their own, without the day-to-day management responsibilities. 
Potential Annual Returns: 
Appreciation: Historically, institutional-grade properties including apartment complexes, retail centers, and commercial buildings of properties have shown average annual appreciation rates ranging from 3% to 5% in stable markets over the long term.  
Annual Return: DSTs typically focus on income-producing properties, such as apartment complexes, commercial buildings, or retail centers. Investors on average can expect between a 4-9% annual rate of return.  
Total Annual Return: Based on the above averages for Appreciation and annual return income, a total between 7% – 14% annual returns could be expected, equating to $140,000-$280,000 annually. 
Tax Benefits: DST investors generally receive an annual statement from the Sponsor allocating the investors share of depreciation, mortgage interest, property taxes, and other tax benefits. 
Diversification: DSTs provide diversification by allowing investors to own a portion of multiple properties within a single investment. This diversification can mitigate risks associated with a single property or market. 

1031 Exchanges Impact on Return on Investment 
In conclusion, utilizing a 1031 Exchange to transition from one property to another is a strategic move for property owners or investors looking to optimize their real estate investments. By carefully considering the potential returns and characteristics of traditional investments compared to like-kind real estate investments, investors can increase their reinvestment and tailor their real estate investments to align with their financial goals and risk tolerance. 
Before embarking on a 1031 Exchange, it is crucial to consult with tax professionals, legal advisors, and real estate experts to ensure compliance with regulations and to make informed decisions. Additionally, market conditions and investment landscapes can change, so staying informed about current trends and conducting thorough due diligence is essential for long-term success in real estate investing. 
A well-executed 1031 Exchange can not only defer four levels of tax but also serve as a catalyst for diversification, capital growth, and enhanced income streams within a carefully curated real estate portfolio. 
 
The material in this blog is presented for informational purposes only. The information presented is not investment, legal, tax or compliance advice. Accruit performs the duties of a Qualified Intermediary, and as such does not offer or sell investments or provide investment, legal, or tax advice. 

Evolution 
The idea that an exchange of a like kind property for another should not subject a Taxpayer, or Exchanger, to a tax payment so long as they did not “cash out” formed the basis for Section 1031 to become part of the Tax Code in 1921. At one time almost all asset types could be exchanged, but in the present era, only real estate can be exchanged. The rationale for this tax deferral was based on the fact that the Exchanger maintained a “continuity of investment” in the asset, and it would be unfair to assess a tax under the circumstances of maintaining the investment in the “like kind” property. Then, as well as now, applicable taxes were deferred until some final cash out disposition, if any. 
There were additions to the Code section over time but there were still a lot of open questions as the use of §1031 gathered steam over the years. In 1991, the IRS sought to provide more certainty on what could or could not be done and promulgated some regulations to provide a safe harbor that people could follow when entering into a tax deferred exchange. The 1991 regulations included distinct safe harbors:  

Security or Guaranty Arrangements 

Qualified Escrow and Qualified Trust Accounts 

Use of Qualified Intermediaries 

Interest and Growth Factors 

During a comment period before the 1991 rules came into effect, many people wrote in to the Internal Revenue Service (IRS) asking if the final rules could provide some guidance when circumstances dictated that the Replacement Property needed to be acquired before the sale of the Relinquished Property, commonly referred to as a Reverse Exchange, or when a portion of the Relinquished Property sale proceeds needed to be allocated to construction or improvement on the new property, a Construction or Improvement exchange. The IRS replied to these comments by declining to include such guidance but indicated that it would continue to study the issue and provide rules on it in the future. It took some time, but in the year 2000, that guidance was published in Revenue Procedure 2000-37.
Safe Harbor for Reverse and Improvement Exchanges 
Like the Forward Exchange Rules before it, IRS Rev. Proc. 2000-37 provided a new safe harbor for Reverse and Construction/Improvement Exchanges. Among other things, the rules required having a third party, referred to as an Exchange Accommodation Titleholder, park title to the subject property as part of the necessary structure. Also, it was a condition of the safe harbor that the transaction, including the title parking arrangement, could go on no longer than 180 days. 
Traditional Structuring for Reverse and Improvement Exchange Prior to the Safe Harbor 
Prior to the issuance of this Rev. Proc. in 2000, there was some case law on Reverse and Property Improvement Exchanges. The gist of which was that it could be done via a title parking arrangement, but it was necessary for the third-party parking Accommodator to have true “benefits and burdens” of ownership. This was a very high bar to reach and required such things as: 

Risk of gain or loss required should the market value change over the term of the parking arrangement 

“Skin in the game” from the Accommodator, often thought to be a minimum of 5% of the equity 

Lease of the property back to the Exchanger during the parking term with true economics and arm’s length dealing 

Exchanger could not be the agent of the accommodator 

Exchanger could not simply provide a blanket guarantee on any bank loan made to the Accommodator for the purchase price and/or cost of improvements 

As can be imagined, meeting these criteria suggested by the case law was hard to do. The 2000 regulations changed most of this and for all intents and purposes just required the Accommodator to be in legal title during the 180 term of the transaction. Simplifying the requirements provided many Exchangers the ability to enter into these parking arrangements without tax risk. 
Rev. Proc. Position on Structuring Outside the Safe Harbor 
The regulations recognized that it was not always possible to have a parking transaction be concluded within 180 days. For example, in the case of new construction or property improvements, it takes time to get architect plans, permits, deal with inclement weather conditions, etc. Taking this into consideration, the Regs included a paragraph suggesting that “no (adverse) inference” was to be made for deals structured outside the safe harbor, specifically it states: 
“No inference is intended with respect to the federal income tax treatment of arrangements similar to those described in this revenue procedure that were entered into prior to the effective date of this revenue procedure. Further, the Service recognizes that “parking” transactions can be accomplished outside of the safe harbor provided in this revenue procedure. Accordingly, no inference is intended with respect to the federal income tax treatment of “parking” transactions that do not satisfy the terms of the safe harbor provided in this revenue procedure, whether entered into prior to or after the effective date of this revenue procedure.”
This language was meant to leave the window open for matters that required more than 180 days to accomplish a completed exchange. For transactions that could only be done for a period in excess of 180 days, the only practical way was to resort to the benefits and burdens approach referred to above and, as before, that was difficult to adhere to. 
The Case of Estate of George H. Bartell, Jr. v. Commissioner, 147 T.C. No. 5 (2016) 
As so many times before, the landscape for these transactions changed once again with the ruling in the Bartell case that was issued in 2016. That case pertained to a taxpayer who structured an exchange involving new construction with a corresponding parking arrangement for 24 months. The actual period ended up being 17 months. Unlike traditional deals outside the safe harbor, it did not have benefits and burdens built in, rather it merely had a third-party Accommodator, referred to by the Court as a “warehousing” entity, hold title during the parking term. Predictably, the IRS challenged the tax reporting since it did not comply with historical requirements for a structure outside the safe harbor. However, the Federal District Court examined some cases on the subject and reached the conclusion that the case law primarily required a third party to be in title to the property during the period of construction. 
This finding by the Court was a radical departure from what practitioners expected and opened up the door to many more parking transactions to be structured following the Bartell model. While the IRS was bound by the decision, it expressed its continuing disagreement with the holding by filing a “non-acquiesce” to the decision, meaning that it did not agree to be bound by it in other cases. This meant that persons in other Federal Districts could not necessarily rely on the case holding as applicable law. 
However, gradually since 2016 real estate investors and business owners have been structuring deals requiring more than 180 days in conformity with the Bartell decision. At this time in 2024, such a matter being done outside the safe harbor is somewhat commonplace and certainly the IRS is aware that it happens. A lot of time has elapsed since the case holding and there is no evidence that the IRS has disallowed this structure since then so it would seem that a parking arrangement that uses an Accommodator but does not require benefits and burdens to that party, is indeed possible.  
Like all tax related matters that are not the equivalent of a published safe harbor, it is always recommended to seek advice from your professional advisers to ensure that any perceived tax risk is properly assessed. 
 
The material in this blog is presented for informational purposes only. The information presented is not investment, legal, tax or compliance advice. Accruit performs the duties of a Qualified Intermediary, and as such does not offer or sell investments or provide investment, legal, or tax advice. 

Evolution 
The idea that an exchange of a like kind property for another should not subject a Taxpayer, or Exchanger, to a tax payment so long as they did not “cash out” formed the basis for Section 1031 to become part of the Tax Code in 1921. At one time almost all asset types could be exchanged, but in the present era, only real estate can be exchanged. The rationale for this tax deferral was based on the fact that the Exchanger maintained a “continuity of investment” in the asset, and it would be unfair to assess a tax under the circumstances of maintaining the investment in the “like kind” property. Then, as well as now, applicable taxes were deferred until some final cash out disposition, if any. 
There were additions to the Code section over time but there were still a lot of open questions as the use of §1031 gathered steam over the years. In 1991, the IRS sought to provide more certainty on what could or could not be done and promulgated some regulations to provide a safe harbor that people could follow when entering into a tax deferred exchange. The 1991 regulations included distinct safe harbors:  

Security or Guaranty Arrangements 

Qualified Escrow and Qualified Trust Accounts 

Use of Qualified Intermediaries 

Interest and Growth Factors 

During a comment period before the 1991 rules came into effect, many people wrote in to the Internal Revenue Service (IRS) asking if the final rules could provide some guidance when circumstances dictated that the Replacement Property needed to be acquired before the sale of the Relinquished Property, commonly referred to as a Reverse Exchange, or when a portion of the Relinquished Property sale proceeds needed to be allocated to construction or improvement on the new property, a Construction or Improvement exchange. The IRS replied to these comments by declining to include such guidance but indicated that it would continue to study the issue and provide rules on it in the future. It took some time, but in the year 2000, that guidance was published in Revenue Procedure 2000-37.
Safe Harbor for Reverse and Improvement Exchanges 
Like the Forward Exchange Rules before it, IRS Rev. Proc. 2000-37 provided a new safe harbor for Reverse and Construction/Improvement Exchanges. Among other things, the rules required having a third party, referred to as an Exchange Accommodation Titleholder, park title to the subject property as part of the necessary structure. Also, it was a condition of the safe harbor that the transaction, including the title parking arrangement, could go on no longer than 180 days. 
Traditional Structuring for Reverse and Improvement Exchange Prior to the Safe Harbor 
Prior to the issuance of this Rev. Proc. in 2000, there was some case law on Reverse and Property Improvement Exchanges. The gist of which was that it could be done via a title parking arrangement, but it was necessary for the third-party parking Accommodator to have true “benefits and burdens” of ownership. This was a very high bar to reach and required such things as: 

Risk of gain or loss required should the market value change over the term of the parking arrangement 

“Skin in the game” from the Accommodator, often thought to be a minimum of 5% of the equity 

Lease of the property back to the Exchanger during the parking term with true economics and arm’s length dealing 

Exchanger could not be the agent of the accommodator 

Exchanger could not simply provide a blanket guarantee on any bank loan made to the Accommodator for the purchase price and/or cost of improvements 

As can be imagined, meeting these criteria suggested by the case law was hard to do. The 2000 regulations changed most of this and for all intents and purposes just required the Accommodator to be in legal title during the 180 term of the transaction. Simplifying the requirements provided many Exchangers the ability to enter into these parking arrangements without tax risk. 
Rev. Proc. Position on Structuring Outside the Safe Harbor 
The regulations recognized that it was not always possible to have a parking transaction be concluded within 180 days. For example, in the case of new construction or property improvements, it takes time to get architect plans, permits, deal with inclement weather conditions, etc. Taking this into consideration, the Regs included a paragraph suggesting that “no (adverse) inference” was to be made for deals structured outside the safe harbor, specifically it states: 
“No inference is intended with respect to the federal income tax treatment of arrangements similar to those described in this revenue procedure that were entered into prior to the effective date of this revenue procedure. Further, the Service recognizes that “parking” transactions can be accomplished outside of the safe harbor provided in this revenue procedure. Accordingly, no inference is intended with respect to the federal income tax treatment of “parking” transactions that do not satisfy the terms of the safe harbor provided in this revenue procedure, whether entered into prior to or after the effective date of this revenue procedure.”
This language was meant to leave the window open for matters that required more than 180 days to accomplish a completed exchange. For transactions that could only be done for a period in excess of 180 days, the only practical way was to resort to the benefits and burdens approach referred to above and, as before, that was difficult to adhere to. 
The Case of Estate of George H. Bartell, Jr. v. Commissioner, 147 T.C. No. 5 (2016) 
As so many times before, the landscape for these transactions changed once again with the ruling in the Bartell case that was issued in 2016. That case pertained to a taxpayer who structured an exchange involving new construction with a corresponding parking arrangement for 24 months. The actual period ended up being 17 months. Unlike traditional deals outside the safe harbor, it did not have benefits and burdens built in, rather it merely had a third-party Accommodator, referred to by the Court as a “warehousing” entity, hold title during the parking term. Predictably, the IRS challenged the tax reporting since it did not comply with historical requirements for a structure outside the safe harbor. However, the Federal District Court examined some cases on the subject and reached the conclusion that the case law primarily required a third party to be in title to the property during the period of construction. 
This finding by the Court was a radical departure from what practitioners expected and opened up the door to many more parking transactions to be structured following the Bartell model. While the IRS was bound by the decision, it expressed its continuing disagreement with the holding by filing a “non-acquiesce” to the decision, meaning that it did not agree to be bound by it in other cases. This meant that persons in other Federal Districts could not necessarily rely on the case holding as applicable law. 
However, gradually since 2016 real estate investors and business owners have been structuring deals requiring more than 180 days in conformity with the Bartell decision. At this time in 2024, such a matter being done outside the safe harbor is somewhat commonplace and certainly the IRS is aware that it happens. A lot of time has elapsed since the case holding and there is no evidence that the IRS has disallowed this structure since then so it would seem that a parking arrangement that uses an Accommodator but does not require benefits and burdens to that party, is indeed possible.  
Like all tax related matters that are not the equivalent of a published safe harbor, it is always recommended to seek advice from your professional advisers to ensure that any perceived tax risk is properly assessed. 
 
The material in this blog is presented for informational purposes only. The information presented is not investment, legal, tax or compliance advice. Accruit performs the duties of a Qualified Intermediary, and as such does not offer or sell investments or provide investment, legal, or tax advice. 

Evolution 
The idea that an exchange of a like kind property for another should not subject a Taxpayer, or Exchanger, to a tax payment so long as they did not “cash out” formed the basis for Section 1031 to become part of the Tax Code in 1921. At one time almost all asset types could be exchanged, but in the present era, only real estate can be exchanged. The rationale for this tax deferral was based on the fact that the Exchanger maintained a “continuity of investment” in the asset, and it would be unfair to assess a tax under the circumstances of maintaining the investment in the “like kind” property. Then, as well as now, applicable taxes were deferred until some final cash out disposition, if any. 
There were additions to the Code section over time but there were still a lot of open questions as the use of §1031 gathered steam over the years. In 1991, the IRS sought to provide more certainty on what could or could not be done and promulgated some regulations to provide a safe harbor that people could follow when entering into a tax deferred exchange. The 1991 regulations included distinct safe harbors:  

Security or Guaranty Arrangements 

Qualified Escrow and Qualified Trust Accounts 

Use of Qualified Intermediaries 

Interest and Growth Factors 

During a comment period before the 1991 rules came into effect, many people wrote in to the Internal Revenue Service (IRS) asking if the final rules could provide some guidance when circumstances dictated that the Replacement Property needed to be acquired before the sale of the Relinquished Property, commonly referred to as a Reverse Exchange, or when a portion of the Relinquished Property sale proceeds needed to be allocated to construction or improvement on the new property, a Construction or Improvement exchange. The IRS replied to these comments by declining to include such guidance but indicated that it would continue to study the issue and provide rules on it in the future. It took some time, but in the year 2000, that guidance was published in Revenue Procedure 2000-37.
Safe Harbor for Reverse and Improvement Exchanges 
Like the Forward Exchange Rules before it, IRS Rev. Proc. 2000-37 provided a new safe harbor for Reverse and Construction/Improvement Exchanges. Among other things, the rules required having a third party, referred to as an Exchange Accommodation Titleholder, park title to the subject property as part of the necessary structure. Also, it was a condition of the safe harbor that the transaction, including the title parking arrangement, could go on no longer than 180 days. 
Traditional Structuring for Reverse and Improvement Exchange Prior to the Safe Harbor 
Prior to the issuance of this Rev. Proc. in 2000, there was some case law on Reverse and Property Improvement Exchanges. The gist of which was that it could be done via a title parking arrangement, but it was necessary for the third-party parking Accommodator to have true “benefits and burdens” of ownership. This was a very high bar to reach and required such things as: 

Risk of gain or loss required should the market value change over the term of the parking arrangement 

“Skin in the game” from the Accommodator, often thought to be a minimum of 5% of the equity 

Lease of the property back to the Exchanger during the parking term with true economics and arm’s length dealing 

Exchanger could not be the agent of the accommodator 

Exchanger could not simply provide a blanket guarantee on any bank loan made to the Accommodator for the purchase price and/or cost of improvements 

As can be imagined, meeting these criteria suggested by the case law was hard to do. The 2000 regulations changed most of this and for all intents and purposes just required the Accommodator to be in legal title during the 180 term of the transaction. Simplifying the requirements provided many Exchangers the ability to enter into these parking arrangements without tax risk. 
Rev. Proc. Position on Structuring Outside the Safe Harbor 
The regulations recognized that it was not always possible to have a parking transaction be concluded within 180 days. For example, in the case of new construction or property improvements, it takes time to get architect plans, permits, deal with inclement weather conditions, etc. Taking this into consideration, the Regs included a paragraph suggesting that “no (adverse) inference” was to be made for deals structured outside the safe harbor, specifically it states: 
“No inference is intended with respect to the federal income tax treatment of arrangements similar to those described in this revenue procedure that were entered into prior to the effective date of this revenue procedure. Further, the Service recognizes that “parking” transactions can be accomplished outside of the safe harbor provided in this revenue procedure. Accordingly, no inference is intended with respect to the federal income tax treatment of “parking” transactions that do not satisfy the terms of the safe harbor provided in this revenue procedure, whether entered into prior to or after the effective date of this revenue procedure.”
This language was meant to leave the window open for matters that required more than 180 days to accomplish a completed exchange. For transactions that could only be done for a period in excess of 180 days, the only practical way was to resort to the benefits and burdens approach referred to above and, as before, that was difficult to adhere to. 
The Case of Estate of George H. Bartell, Jr. v. Commissioner, 147 T.C. No. 5 (2016) 
As so many times before, the landscape for these transactions changed once again with the ruling in the Bartell case that was issued in 2016. That case pertained to a taxpayer who structured an exchange involving new construction with a corresponding parking arrangement for 24 months. The actual period ended up being 17 months. Unlike traditional deals outside the safe harbor, it did not have benefits and burdens built in, rather it merely had a third-party Accommodator, referred to by the Court as a “warehousing” entity, hold title during the parking term. Predictably, the IRS challenged the tax reporting since it did not comply with historical requirements for a structure outside the safe harbor. However, the Federal District Court examined some cases on the subject and reached the conclusion that the case law primarily required a third party to be in title to the property during the period of construction. 
This finding by the Court was a radical departure from what practitioners expected and opened up the door to many more parking transactions to be structured following the Bartell model. While the IRS was bound by the decision, it expressed its continuing disagreement with the holding by filing a “non-acquiesce” to the decision, meaning that it did not agree to be bound by it in other cases. This meant that persons in other Federal Districts could not necessarily rely on the case holding as applicable law. 
However, gradually since 2016 real estate investors and business owners have been structuring deals requiring more than 180 days in conformity with the Bartell decision. At this time in 2024, such a matter being done outside the safe harbor is somewhat commonplace and certainly the IRS is aware that it happens. A lot of time has elapsed since the case holding and there is no evidence that the IRS has disallowed this structure since then so it would seem that a parking arrangement that uses an Accommodator but does not require benefits and burdens to that party, is indeed possible.  
Like all tax related matters that are not the equivalent of a published safe harbor, it is always recommended to seek advice from your professional advisers to ensure that any perceived tax risk is properly assessed. 
 
The material in this blog is presented for informational purposes only. The information presented is not investment, legal, tax or compliance advice. Accruit performs the duties of a Qualified Intermediary, and as such does not offer or sell investments or provide investment, legal, or tax advice. 

History of Related Parties in 1031 Exchanges
IRC Section 1031 has been part of the Tax Code since 1921. Then, as now, the rationale for tax deferral has been the continuity of the investment by the Exchanger. Simple stated, the Exchanger owned real estate that appreciated over time, sold it, and reinvested all of it into new real estate. Why impose a tax on these facts when the real estate investment continued and there was no cash out along the way?
However, over time crafty Exchangers, or their advisors, sought to exploit this highly favorable tax treatment by using related parties, such as corporate subsidiaries, and trading real estate with such parties. So, for example, if Company A had a high value property with a low basis, it could exchange the property with its subsidiary, Company AB, for a property with a high basis and high value comparable to the value of the Company A property. Company A would receive tax deferral. Company AB would then sell the property it received in the exchange and due to its high basis, Company AB would have little or no tax to pay. This was characterized as an “abusive basis shift” done merely so the group of companies could divest from the property with high gain achieving a non-tax outcome.
Related Party Rules
Eventually, Congress sought to end this practice by adding the Related Party Rules into Code Section 1031, the provision disallowed the exchange if either Related Party sold the property it received within two years of the exchange. The result Section 1031(f)(1), which states that if either Related Party exchanger disposes of its Replacement Property within the two-year period, both exchangers must recognize the gain or loss deferred on the original exchange as of the date of the subsequent disposition. Presumably the substantial holding period was considered enough to discourage people or companies from structuring these transactions with the primary motive of tax avoidance. Notably, Section 1031(f)(4) also imposes an anti-abuse rule, which provides in full as follows: “This section shall not apply to any exchange which is part of a transaction (or series of transactions) structured to avoid the purposes of this subsection.
It should be noted that selling Relinquished Property to a Related Party is not prohibited because that action would not lead to tax abuse possible with a purchase from a Related Party.
Exceptions to Related Party Rules
There are also several additional exceptions that would allow for a Related Party exchange. The first requires being able to prove to the IRS that “neither the exchange nor such disposition had as one of its principal purposes the avoidance of Federal income tax.” Since, almost by definition, tax deferral is typically a principal purpose of an exchange, this “proof” is a high bar. There are some cases where this exception has been successful where family members have interests in multiple properties together and they want to do exchanges to consolidate single properties with single family members. An additional exception came up later where an IRS ruling found that should the Related Party transferring the Replacement Property to the Exchanger do his own exchange, then that was indicative that the transaction was not simply to sell the original low basis property through the Related Party who had the high basis.
Section 1031(f)(2)(C) allows Exchangers to exchange property with a related person without triggering gain or loss recognition, as long as the exchange is not done for tax avoidance purposes. Under section 1031(f)(2)(C), there must be a primary business purpose for exchanging property with a related person. The Senate Finance Committee provided three examples of exchanges that would qualify for this exception:

An exchange of fractional interests in different properties that results in each taxpayer owning either the whole property or a larger share of it.
A disposition of property in a transaction that does not recognize gain or loss, such as a contribution to a partnership or a corporation.
An exchange that does not change the basis of the properties involved, meaning that the total basis of the exchanged properties remains the same before and after the transaction.

The IRS has issued two rulings that confirm these examples and allow Exchangers to use section 1031(f)(2)(C) in these situations. PLR 1999926045 (July 6, 1999) and PLR 200706001 (February 9, 2007).
Who Constitutes as a Related Party?
As discussed, Section 1031(f) deals with exchanges of property between Related Parties. Related Parties include family members like spouses, parents, and siblings, as well as entities that are affiliated or controlled by the same person or group. For example, a parent corporation and its subsidiaries are Related Parties. A partnership and a person who owns more than half of the partnership are also Related Parties. The same applies to two partnerships with the same owners. To determine who owns what, section 267 rules are used.
Attribution Rules for Identifying Related Parties
Section 267(b) and Section 707(b) of the Internal Revenue Code have very broad attribution rules. They consider not only family members (such as parents and children) but also related trusts, partnerships, and corporations as “disqualified persons”. These rules can be very tedious to apply, as they require tracing familial and other connections. The rules also treat agents and related persons as “disqualified persons”. Moreover, a person is a “disqualified person” if he is related to another “disqualified person” of the Exchanger under Section 267(b) or Section 707(b). This makes the relatedness rules very extensive.
Although the Exchanger can still buy the Replacement Property from people who are not considered related, such as in-laws, nephews, nieces, aunts, uncles, friends, employees, companions, or entities where the Exchanger or a Related Party has a 50% or less ownership interest, the following are the definitions from the Tax Code § 267(b) on what relations constitute related parties:
267(b) RELATIONSHIPS
(1) Members of a family, as defined in subsection (c)(4);
(2) An individual and a corporation more than 50 percent in value of the outstanding stock of which is owned, directly or indirectly, by or for such individual (attribution rules apply);
(3) Two corporations which are members of the same controlled group (as defined in subsection (f));
(4) A grantor and a fiduciary of any trust;
(5) A fiduciary of a trust and a fiduciary of another trust, if the same person is a grantor of both trusts;
(6) A fiduciary of a trust and a beneficiary of such trust;
(7) A fiduciary of a trust and a beneficiary of another trust, if the same person is a grantor of both trusts;
(8) A fiduciary of a trust and a corporation more than 50 percent in value of the outstanding stock of which is owned, directly or indirectly, by or for the trust or by or for a person who is a grantor of the trust;
(9) A person and an organization to which section 501 (relating to certain educational and charitable organizations which are exempt from tax) applies and which is controlled directly or indirectly by such person or (if such person is an individual) by members of the family of such individual;
(10) A corporation and a partnership if the same persons own—
(A) more than 50 percent in value of the outstanding stock of the corporation (attribution rules apply); and
(B) more than 50 percent of the capital interest, or the profits interest, in the partnership (attribution rules apply);
(11) An S corporation and another S corporation if the same persons own more than 50 percent in value of the outstanding stock of each corporation (attribution rules apply);
(12) An S corporation and a C corporation, if the same persons own more than 50 percent in value of the outstanding stock of each corporation (attribution rules apply); or
(13) Except in the case of a sale or exchange in satisfaction of a pecuniary bequest, an executor of an estate and a beneficiary of such estate.
In sum, affiliated entities, commonly controlled entities, and family members such as a spouse, ancestors, and siblings are Related Parties under section 267(b). A controlled group consists of a common parent corporation and one or more subsidiary corporations that are linked by stock ownership. The common parent corporation must own more than 50% (by vote or value) of at least one subsidiary corporation, and each subsidiary corporation (except the common parent corporation) must be owned by one or more other corporations in the group by more than 50% (by vote or value).
Section 707(b)(1) also defines the following persons as related: (1) a person who owns, directly or indirectly, more than 50% (capital or profits) of a partnership and the partnership, and (2) two partnerships where the same persons own, directly or indirectly, more than 50% of the capital or profits interests. Section 707(b) applies section 267 attribution rules to indirect ownership of the partnership.
Constructive Receipt Rules
When the attribution rules of I.R.C. § 267(b) apply, a person is deemed to own the interests of his children, spouse, etc. And when the ownership of a capital or profits interest in a partnership or LLC is involved, attribution is determined in accordance with the constructive ownership rules of Section 267(c) (other than Section 267(c)(3)). While in most cases, reference to these rules will quickly enable people to determine if a planned purchase from a related person or entity is prohibited, at times, depending upon the legal nature of the Exchangers, additional reference must be made to the Constructive Ownership provisions set forth in § 267(c). For instance, 267(b) refers to “members of a family,” whereas (c)(4) below confirms that for this purpose which actual relatives constitute family members.
267(c) CONSTRUCTIVE OWNERSHIP OF STOCK
For purposes of determining, in applying subsection (b), the ownership of stock—
(1) Stock owned, directly or indirectly, by or for a corporation, partnership, estate, or trust shall be considered as being owned proportionately by or for its shareholders, partners, or beneficiaries;
(2) An individual shall be considered as owning the stock owned, directly or indirectly, by or for his family;
(3) An individual owning (otherwise than by the application of paragraph (2)) any stock in a corporation shall be considered as owning the stock owned, directly or indirectly, by or for his partner;
(4) The family of an individual shall include only his brothers and sisters (whether by the whole or half blood), spouse, ancestors, and lineal descendants; and
(5) Stock constructively owned by a person by reason of the application of paragraph (1) shall, for the purpose of applying paragraph (1), (2), or (3), be treated as actually owned by such person, but stock constructively owned by an individual by reason of the application of paragraph (2) or (3) shall not be treated as owned by him for the purpose of again applying either of such paragraphs in order to make another the constructive owner of such stock.
In sum, acquiring Replacement Property as part of a 1031 exchange from a Related Party is generally not allowed, although there are some exceptions. In some cases, quick reference to the IRC § 267(b) can clarify if a certain relationship is prohibited. At times, a further reference to § 267(c) might be necessary to make the proper Related Party and attribution determination..
When dealing with these types of complexities, it is always recommended to seek advice from your professional advisers as early in the process as possible to ensure a 1031 exchange is properly structured per the rules and regulations, so you are able to achieve full tax deferral.
 
The material in this blog is presented for informational purposes only. The information presented is not investment, legal, tax or compliance advice. Accruit performs the duties of a Qualified Intermediary, and as such does not offer or sell investments or provide investment, legal, or tax advice.

History of Related Parties in 1031 Exchanges
IRC Section 1031 has been part of the Tax Code since 1921. Then, as now, the rationale for tax deferral has been the continuity of the investment by the Exchanger. Simple stated, the Exchanger owned real estate that appreciated over time, sold it, and reinvested all of it into new real estate. Why impose a tax on these facts when the real estate investment continued and there was no cash out along the way?
However, over time crafty Exchangers, or their advisors, sought to exploit this highly favorable tax treatment by using related parties, such as corporate subsidiaries, and trading real estate with such parties. So, for example, if Company A had a high value property with a low basis, it could exchange the property with its subsidiary, Company AB, for a property with a high basis and high value comparable to the value of the Company A property. Company A would receive tax deferral. Company AB would then sell the property it received in the exchange and due to its high basis, Company AB would have little or no tax to pay. This was characterized as an “abusive basis shift” done merely so the group of companies could divest from the property with high gain achieving a non-tax outcome.
Related Party Rules
Eventually, Congress sought to end this practice by adding the Related Party Rules into Code Section 1031, the provision disallowed the exchange if either Related Party sold the property it received within two years of the exchange. The result Section 1031(f)(1), which states that if either Related Party exchanger disposes of its Replacement Property within the two-year period, both exchangers must recognize the gain or loss deferred on the original exchange as of the date of the subsequent disposition. Presumably the substantial holding period was considered enough to discourage people or companies from structuring these transactions with the primary motive of tax avoidance. Notably, Section 1031(f)(4) also imposes an anti-abuse rule, which provides in full as follows: “This section shall not apply to any exchange which is part of a transaction (or series of transactions) structured to avoid the purposes of this subsection.
It should be noted that selling Relinquished Property to a Related Party is not prohibited because that action would not lead to tax abuse possible with a purchase from a Related Party.
Exceptions to Related Party Rules
There are also several additional exceptions that would allow for a Related Party exchange. The first requires being able to prove to the IRS that “neither the exchange nor such disposition had as one of its principal purposes the avoidance of Federal income tax.” Since, almost by definition, tax deferral is typically a principal purpose of an exchange, this “proof” is a high bar. There are some cases where this exception has been successful where family members have interests in multiple properties together and they want to do exchanges to consolidate single properties with single family members. An additional exception came up later where an IRS ruling found that should the Related Party transferring the Replacement Property to the Exchanger do his own exchange, then that was indicative that the transaction was not simply to sell the original low basis property through the Related Party who had the high basis.
Section 1031(f)(2)(C) allows Exchangers to exchange property with a related person without triggering gain or loss recognition, as long as the exchange is not done for tax avoidance purposes. Under section 1031(f)(2)(C), there must be a primary business purpose for exchanging property with a related person. The Senate Finance Committee provided three examples of exchanges that would qualify for this exception:

An exchange of fractional interests in different properties that results in each taxpayer owning either the whole property or a larger share of it.
A disposition of property in a transaction that does not recognize gain or loss, such as a contribution to a partnership or a corporation.
An exchange that does not change the basis of the properties involved, meaning that the total basis of the exchanged properties remains the same before and after the transaction.

The IRS has issued two rulings that confirm these examples and allow Exchangers to use section 1031(f)(2)(C) in these situations. PLR 1999926045 (July 6, 1999) and PLR 200706001 (February 9, 2007).
Who Constitutes as a Related Party?
As discussed, Section 1031(f) deals with exchanges of property between Related Parties. Related Parties include family members like spouses, parents, and siblings, as well as entities that are affiliated or controlled by the same person or group. For example, a parent corporation and its subsidiaries are Related Parties. A partnership and a person who owns more than half of the partnership are also Related Parties. The same applies to two partnerships with the same owners. To determine who owns what, section 267 rules are used.
Attribution Rules for Identifying Related Parties
Section 267(b) and Section 707(b) of the Internal Revenue Code have very broad attribution rules. They consider not only family members (such as parents and children) but also related trusts, partnerships, and corporations as “disqualified persons”. These rules can be very tedious to apply, as they require tracing familial and other connections. The rules also treat agents and related persons as “disqualified persons”. Moreover, a person is a “disqualified person” if he is related to another “disqualified person” of the Exchanger under Section 267(b) or Section 707(b). This makes the relatedness rules very extensive.
Although the Exchanger can still buy the Replacement Property from people who are not considered related, such as in-laws, nephews, nieces, aunts, uncles, friends, employees, companions, or entities where the Exchanger or a Related Party has a 50% or less ownership interest, the following are the definitions from the Tax Code § 267(b) on what relations constitute related parties:
267(b) RELATIONSHIPS
(1) Members of a family, as defined in subsection (c)(4);
(2) An individual and a corporation more than 50 percent in value of the outstanding stock of which is owned, directly or indirectly, by or for such individual (attribution rules apply);
(3) Two corporations which are members of the same controlled group (as defined in subsection (f));
(4) A grantor and a fiduciary of any trust;
(5) A fiduciary of a trust and a fiduciary of another trust, if the same person is a grantor of both trusts;
(6) A fiduciary of a trust and a beneficiary of such trust;
(7) A fiduciary of a trust and a beneficiary of another trust, if the same person is a grantor of both trusts;
(8) A fiduciary of a trust and a corporation more than 50 percent in value of the outstanding stock of which is owned, directly or indirectly, by or for the trust or by or for a person who is a grantor of the trust;
(9) A person and an organization to which section 501 (relating to certain educational and charitable organizations which are exempt from tax) applies and which is controlled directly or indirectly by such person or (if such person is an individual) by members of the family of such individual;
(10) A corporation and a partnership if the same persons own—
(A) more than 50 percent in value of the outstanding stock of the corporation (attribution rules apply); and
(B) more than 50 percent of the capital interest, or the profits interest, in the partnership (attribution rules apply);
(11) An S corporation and another S corporation if the same persons own more than 50 percent in value of the outstanding stock of each corporation (attribution rules apply);
(12) An S corporation and a C corporation, if the same persons own more than 50 percent in value of the outstanding stock of each corporation (attribution rules apply); or
(13) Except in the case of a sale or exchange in satisfaction of a pecuniary bequest, an executor of an estate and a beneficiary of such estate.
In sum, affiliated entities, commonly controlled entities, and family members such as a spouse, ancestors, and siblings are Related Parties under section 267(b). A controlled group consists of a common parent corporation and one or more subsidiary corporations that are linked by stock ownership. The common parent corporation must own more than 50% (by vote or value) of at least one subsidiary corporation, and each subsidiary corporation (except the common parent corporation) must be owned by one or more other corporations in the group by more than 50% (by vote or value).
Section 707(b)(1) also defines the following persons as related: (1) a person who owns, directly or indirectly, more than 50% (capital or profits) of a partnership and the partnership, and (2) two partnerships where the same persons own, directly or indirectly, more than 50% of the capital or profits interests. Section 707(b) applies section 267 attribution rules to indirect ownership of the partnership.
Constructive Receipt Rules
When the attribution rules of I.R.C. § 267(b) apply, a person is deemed to own the interests of his children, spouse, etc. And when the ownership of a capital or profits interest in a partnership or LLC is involved, attribution is determined in accordance with the constructive ownership rules of Section 267(c) (other than Section 267(c)(3)). While in most cases, reference to these rules will quickly enable people to determine if a planned purchase from a related person or entity is prohibited, at times, depending upon the legal nature of the Exchangers, additional reference must be made to the Constructive Ownership provisions set forth in § 267(c). For instance, 267(b) refers to “members of a family,” whereas (c)(4) below confirms that for this purpose which actual relatives constitute family members.
267(c) CONSTRUCTIVE OWNERSHIP OF STOCK
For purposes of determining, in applying subsection (b), the ownership of stock—
(1) Stock owned, directly or indirectly, by or for a corporation, partnership, estate, or trust shall be considered as being owned proportionately by or for its shareholders, partners, or beneficiaries;
(2) An individual shall be considered as owning the stock owned, directly or indirectly, by or for his family;
(3) An individual owning (otherwise than by the application of paragraph (2)) any stock in a corporation shall be considered as owning the stock owned, directly or indirectly, by or for his partner;
(4) The family of an individual shall include only his brothers and sisters (whether by the whole or half blood), spouse, ancestors, and lineal descendants; and
(5) Stock constructively owned by a person by reason of the application of paragraph (1) shall, for the purpose of applying paragraph (1), (2), or (3), be treated as actually owned by such person, but stock constructively owned by an individual by reason of the application of paragraph (2) or (3) shall not be treated as owned by him for the purpose of again applying either of such paragraphs in order to make another the constructive owner of such stock.
In sum, acquiring Replacement Property as part of a 1031 exchange from a Related Party is generally not allowed, although there are some exceptions. In some cases, quick reference to the IRC § 267(b) can clarify if a certain relationship is prohibited. At times, a further reference to § 267(c) might be necessary to make the proper Related Party and attribution determination..
When dealing with these types of complexities, it is always recommended to seek advice from your professional advisers as early in the process as possible to ensure a 1031 exchange is properly structured per the rules and regulations, so you are able to achieve full tax deferral.
 
The material in this blog is presented for informational purposes only. The information presented is not investment, legal, tax or compliance advice. Accruit performs the duties of a Qualified Intermediary, and as such does not offer or sell investments or provide investment, legal, or tax advice.