Update on intermediaries and related-party exchanges.

• Author: Hamill, James R.
• Position: Taxation

This item is an update of the May 1997 Tax Clinic item (Vol. 28, No. 5, p. 276) that raised several questions on application of the related-party like-kind exchange provisions to exchanges involving a qualified intermediary (QI). A QI is someone who (1) acquires relinquished property from the taxpayer, (2) transfers the relinquished property to the buyer of that property, (3) acquires replacement property from the seller of that property and (4) transfers the replacement property to the taxpayer. The QI allows for an exchange when the buyer of the relinquished property is unwilling to acquire and transfer replacement property.

Related-party exchanges can accelerate deferred gain when the taxpayer or the related party disposes of property received in the exchange within two years of the exchange (Sec. 1031(f)(1)). An exception exists for dispositions that lack a principal purpose of tax avoidance (Sec. 1031(f)(2)(C)). Form 8824, Like-Kind Exchanges (and non-recognition of gain from conflict-of-interest sales), is used to report like kind exchanges; a special section must be completed to report related-party exchanges. If the "no tax avoidance" exception is relied on to avoid acceleration of gain from the exchange, the taxpayer must attach an explanation as to why it applies.

The May 1997 item noted that an exchange using a QI, in which a related party was the seller of replacement property, did not squarely fit within the definition of a Sec. 1031(f)(1) related-party exchange, because, technically, the exchange was made with the QI. It also mentioned that the IRS would likely view such an exchange as a related-party exchange, but that the taxpayer may be justified in not completing the related-party section of Form 8824.

In Letter Ruling (TAM) 9748006, the Service applied the related-party exchange rules to a QI exchange involving related parties. However, the facts and analysis of this ruling leave unanswered several of the questions raised in the May 1997 item.

Example: T, a taxpayer, owned a one-third interest in land and RP, a related party, owned a two-thirds interest in that land. B, a buyer, wanted the entire tract; T and RP contracted with B to transfer full ownership of the land. A QI was used to acquire and transfer the land from T and RP to B. Independent of the exchange, RP purchased a house to be used as a principal residence. Twanted to defer gain from the sale of his one-third interest in the land and attempted to acquire...