6.6 Exchanges Between Related Parties

A like-kind exchange between related persons may be disqualified if either party disposes of the property received in the exchange within two years after the date of the last transfer that was part of the exchange. Unless an exception applies, any gain deferred on the original exchange becomes taxable when the original like-kind property is disposed of by either party within the two-year period. If a loss was deferred on the original exchange, the loss becomes deductible if allowed under the rules in 5.6.

Indirect dispositions of the property within the two-year period, such as transfer of stock of a corporation or interests in a partnership that owns the property, may also be treated as taxable dispositions.

Related parties.

Related persons falling within the two-year rule include your children, grandchildren, parent, brother, or sister, controlled corporations or partnerships (more than 50% ownership), and a trust in which you are a beneficiary. A transfer to a spouse is not subject to the two-year rule unless he or she is a nonresident alien.

Filing Instruction

Filing Form 8824

The IRS requires related parties who exchange property to file Form 8824 for the year of the exchange and also for the two years following the exchange. If either party disposes of the property received in the original exchange in any of these years, the gain deferred on the original exchange must be reported in the year of disposition.

The two-year period is suspended for a holder of exchanged property who has substantially diminished his or her risk of loss, such as by use of a put or short sale.

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Plan to avoid two-year rule.

If you set up a prearranged plan under which you first transfer property to an unrelated party who within two years makes an exchange with a party related to you, the related party will not qualify for tax-free treatment on that exchange.

Exceptions.

No tax will be incurred on a disposition made after the death of either related party; in an involuntary conversion provided the original exchange occurred before the threat of the conversion; or if you can prove that neither the exchange nor the later disposition was for a tax avoidance purpose.