1031 with family: related-party rules

By Tom, CPA · Updated October 27, 2026

Part of: Rental Property Taxes

TL;DR: Exchanges with related parties (spouse, siblings, parents, children, grandchildren and more-than-50%-owned entities) are allowed, but if either side disposes of its property within two years, the deferred gain becomes taxable. Buying replacement property from a relative through a QI, where the relative cashes out, is usually disallowed outright.

Educational only, not tax, legal, or investment advice. Examples are illustrations, not predictions. Rules and limits change; verify current figures and talk to a qualified professional about your situation.

Keeping it in the family is lovely for recipes and terrible for tax shortcuts. Congress noticed that relatives could swap a high-basis property for a low-basis one, sell the high-basis one, and move basis around like a shell game at a county fair. Section 1031(f) shuts the game down, mostly. This guide explains where the line is. Basics first: 1031 exchange basics.

CPA Warning Label: A 1031 with a relative is legal, but if either side sells within two years, or a relative cashes out through your QI, the deferral can collapse.

Section 1031(f)

Under section 1031(f)(1), if you exchange property with a related person, and within two years of the last transfer that was part of the exchange either you or the related person disposes of the property received, the gain that was deferred is recognized as of the date of that later disposition. The exchange itself was fine; the later sale unravels it.

Who is related? Section 1031(f)(3) points to sections 267(b) and 707(b)(1). For individuals that includes:

• Your spouse, siblings (whole or half blood), ancestors (parents, grandparents) and lineal descendants (children, grandchildren).
• A corporation in which you own more than 50% in value (directly or by attribution).
• A partnership in which you own more than 50% of capital or profits.
• Trusts and fiduciaries in various combinations.

Not related under these rules: in-laws, aunts and uncles, nieces and nephews, cousins and step-relatives without adoption. (The family member who always borrows your truck is related only in spirit, unless he is also your brother.) Spouses are related too, though transfers between spouses are usually nonrecognition events under section 1041 anyway. Watch attribution, though: stock owned by your child is treated as owned by you for the 50% tests.

Section 1031(f)(4) adds an anti-abuse rule: any exchange that is part of a transaction or series of transactions structured to avoid the purposes of 1031(f) doesn't get deferral at all.

Two-year hold

The two-year clock starts at the date of the last transfer that was part of the exchange. During that time, neither party can dispose of the property received. Dispositions include sales, gifts in some contexts, and transfers to a partnership. The holding period is also suspended under 1031(g) while either party's risk of loss is substantially diminished (for example, through a put, a short sale or a binding sale contract).

Both parties must report on Form 8824 for the year of the exchange and the two following years, answering the related-party questions in Part II. If a disposition happens, the deferred gain is reported in the year of that disposition.

Exceptions

Section 1031(f)(2) excludes from the two-year rule any disposition:

1. After the death of the taxpayer or the related person;
2. In a compulsory or involuntary conversion (like condemnation or casualty) if the exchange occurred before the threat of conversion; or
3. Where it's established to the IRS's satisfaction that neither the exchange nor the disposition had tax avoidance as one of its principal purposes.

The third exception is the hardest to rely on. Courts have looked at whether the overall effect was to cash out low-basis property while keeping the gain deferred, typically called basis shifting. Exchanges where both parties keep their properties, or where the related party has its own gain to recognize on a sale, look better than ones where cash ends up in the family and the gain disappears.

The QI trap

The most common related-party problem isn't a direct swap. It's a deferred exchange where your QI buys the replacement property from your relative, and your relative takes cash. Rev. Rul. 2002-83 addressed this: a taxpayer transferred low-basis property to a QI, which sold it and bought replacement property from a related party, who received cash. The ruling denied deferral under 1031(f)(4), because the result was the same as a direct related-party exchange followed by the relative's immediate sale.

The Tax Court reached a similar result in Teruya Brothers, Ltd. v. Commissioner (124 T.C. 45 (2005), affirmed by the Ninth Circuit), where related-party transactions ran through an intermediary.

The reverse case, selling your relinquished property to a relative through a QI and buying replacement property from an unrelated seller, is generally considered lower risk because the relative isn't cashing out of investment property. The IRS has issued private letter rulings allowing it in specific facts, but private rulings aren't precedent.

Examples

Illustration 1 (direct swap): Frugal Fran exchanges her rental (basis $100,000, value $500,000) with her brother's rental (basis $480,000, value $500,000). No cash. Both defer. Eighteen months later her brother sells Fran's old rental for $520,000. Under 1031(f), both deferred gains are recognized at the date of his sale: Fran's $400,000 gain and the brother's $20,000. Plus the brother's own $20,000 post-exchange gain on the sale. Fran didn't sell anything, yet she gets a tax bill because of her brother's decision, which is a good reason to put a two-year no-sale agreement in writing before swapping with family.

Illustration 2 (the QI trap): Lavish Larry sells his rental through a QI for $700,000 and identifies a condo owned by his mother. The QI buys it from her for $700,000. Mom gets cash; she has a high basis and little gain. Larry has exchanged out of a low-basis property, and the family has turned a low-basis property into cash with minimal tax. Rev. Rul. 2002-83 says no deferral. Larry's gain is taxable.

Illustration 3 (selling to family): Fran sells her rental to her daughter through a QI and buys a rental from a stranger. The daughter isn't disposing of investment property and receiving cash. This structure is commonly used, though it should be documented and reviewed; there's no published safe harbor.

Safer structures

• Buy replacement property from unrelated sellers. The clean path.
• If you must buy from a relative, the relative should also be exchanging (doing their own 1031 into other property) so the family isn't cashing out. Some practitioners rely on this; get advice.
• Hold both properties at least two years after a direct related-party exchange, and expect to report on Form 8824 for two more years.
• Avoid basis shifting. If the effect is that a low-basis property is sold for cash by someone with high basis, assume the IRS will notice.
• Consider a gift or sale instead. Gifting a rental to your kids carries your basis over (see gifting a rental to kids), and inheritance generally gives a step-up (inherited rental property).

Reporting checklist

• Form 8824, Part II, asks for the related party's name, relationship and identifying number. Complete it for the exchange year.
• File Form 8824 for each of the next two years, answering whether either party disposed of the property.
• If a disposition happened and no exception applies, report the previously deferred gain in that year, with the character it would have had (including depreciation recapture).
• If you rely on the no-tax-avoidance exception, attach an explanation and keep evidence of the business purpose, such as a relative's unexpected job relocation or health issue.
• Keep both parties' basis records; the IRS will look at who got the low-basis property and who got cash.

Expect the IRS to view family deals with extra skepticism because the incentives are obvious. Fair market values should be supported by appraisals, and leases between relatives should be at market rent (see renting to family).

Family entities count too

Your 60%-owned LLC taxed as a partnership is related to you. So is an S corporation where you and your spouse own more than 50% by attribution. Exchanges between your own entities and you, or between two entities you control, follow the same 1031(f) rules. A single-member LLC disregarded for tax isn't a separate person at all, so moving property between you and it isn't an exchange. See partnership rentals and K-1s for multi-owner entities.