How do intermediaries affect related-party exchanges?

• Author: Hamill, James R.

Sec. 1031 provides for deferral of gain or loss realized on an exchange of property when the taxpayer acquires property of a like kind. Sec. 1031(f) provides special rules when the like-kind exchange is between related parties. In such a case, if the taxpayer disposes of the like-kind property received from the related party, or the related party disposes of the property received from the taxpayer, with either disposition occurring within two years of the exchange, the taxpayer must recognize all the gain on the initial exchange. Such gain is reported in the tax year in which the disposition occurs.

Like-kind exchanges must be reported on Form 8824, Like-Kind Exchanges. In Part I of the form, the taxpayer is asked, among other things, whether the exchange was with related party. If the taxpayer answers "yes," he must then complete Part II, which asks for identifying information with respect to the related party and for details of any dispositions by either party within two years.

Some Sec. 1031 exchanges, particularly deferred exchanges, make use of a qualified intermediary. By using a qualified intermediary, together with assignments of contract rights, the overall transaction may be treated as if a direct exchange had occurred between the taxpayer and the intermediary. What occurs if a related party is either the buyer of the relinquished property or the seller of the replacement property, with a qualified intermediary used to complete a deferred exchange? The immediate issue to address when filing the taxpayer's return for the year of the exchange is whether the related-party section of Form 8824 must be completed. A subsequent issue is whether a disposition of property by either related party will trigger the taxpayer's deferred gain. There are no answers to these questions in Sec. 1031 or the regulations thereunder.

The Treasury Department may have recently signaled its views on the application of related-party rules to deferred exchanges using a qualified intermediary. Sec. 168(g) restricts the use of certain cost recovery methods when property is used by a tax-exempt party, including the lease of property to a tax-exempt party. In April 1996, the IRS issued final regulations on related-party like-kind exchanges designed to circumvent the restrictions on cost recovery methods for tax-exempt use property. For example, an exchange of low-basis property leased to a taxpaying lessee for high-basis property leased to a tax-exempt lessee...