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As you are aware, the tax rules provide for nonrecognition
treatment (i.e. no taxable income is created) when property
held for investment purposes or used in a trade or business
is exchanged for “like-kind” property. In general,
you will not recognize (report) gain or loss on the transaction.
Gain will have to be recognized, however, to the extent you
receive cash (or other non-like-kind property) as part of
the exchange. Please let me know if you’d like additional
information on like-kind exchanges in general.
If the exchange is with a related party, however, special
restrictions apply. First, what is meant by related party?
The most common covered relationships are the familial ones:
your brothers, sisters, parents, grandparents, spouse, children
and grandchildren. (More distant relationships are not covered.)
Partnerships and corporations in which you hold more than
a 50% interest are also related parties for these purposes.
Two-year holding period. If
related parties enter into a like-kind exchange, nonrecognition
treatment will be lost if either property in the exchange
is disposed of within two years of the exchange. Here’s
how the rule would apply to a typical exchange involving related
parties:
 Example:
Max and Tim are brothers. Max has a parcel of investment
realty (Whiteacre) with a basis of $4,000 and a value of $10,000.
Tim also has investment realty (Blackacre) that is worth $10,000
and his basis in it is also $10,000.
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Obviously,
if Max simply sells Whiteacre to a third party, he will have
to report his $6,000 gain. Instead, therefore, he and Tim trade
properties. Max thus disposes of Whiteacre but does not recognize
his gain under the like-kind exchange rules. As you may recall,
these rules also provide that the basis of the property you
receive in the exchange will be equal to the basis you had in
the property you gave up. Tim’s basis in his newly-acquired
Whiteacre is thus $10,000, the basis he had in Blackacre. Tim
now (instead of Max) would sell Whiteacre to an unrelated party
for its $10,000 value. Since Tim’s basis is $10,000, he
would have no gain or loss on the sale.
Under
the two-year rule, if Tim’s sale takes place within two
years of his like-kind exchange with Max, Max would lose the
benefits of nonrecognition treatment from the original exchange.
Max would not have to go back and amend his tax return for
the year of the like-kind exchange. Instead, he would report
his gain ($6,000 in this example) in the year Tim sells Whiteacre.
He would also increase his basis in Blackacre by the gain
he recognizes. If Tim waits two years before selling Whiteacre,
Max retains full advantage of the nonrecognition treatment
on the original like-kind exchange.
Filing requirements. You should
also be aware that if you enter into a like-kind exchange
with your [relative], you must file the special like-kind
exchange Form 8824 not only for the year of the exchange but
for the following two years, to keep IRS apprised of the situation.
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