| Sales & Exchanges / Related-party like-kind exchanges |  |
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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. 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. 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. 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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