Deceased Sister’s Trust is not Related Party to Siblings

Related parties are defined by IRC Section 267(b) or 707(b) of the IRS code. Special rules apply to related parties who are involved in a 1031 exchange.

If related parties exchange like-kind property with each other each party must hold the property received for two years before any subsequent disposition occurs, and

A taxpayer cannot sell to an unrelated party and receive replacement property from a related party.

Related parties include ancestors, descendents, siblings and spouses. Related parties do not include the spouse or children of a sibling. A taxpayer doing an exchange with a spouse or child of a sibling is not subject to the related party restrictions and requirements.

In a recent Private Letter Ruling ( PLR 2009192007), a trust for a deceased sibling’s spouse and children was held to not be a “related party” to the surviving siblings for the purposes of Section 1031. This allowed a portion of the inherited farm ownership to be sold while also allowing the other two siblings to retain their ownership and continuing their taxable gain deference.

In this case, the Taxpayer and two siblings co-owned equal shares of farmland as tenants in common. Ownership was held in trusts for each of them (Trusts A, B and C). Child C died and beneficial ownership of assets in trust passed to Child C’s surviving spouse and children. Trust C now wanted to sell its share of the farmland.

The tenancy in common interest of each trust was converted to fee simple interests in the same property through subdivision. This was technically an exchange between the three trusts. After the exchange of the undivided interests for whole parcels, the husband of the deceased sister, via Trust C, quickly sold its parcel to an outside, third party. The other two siblings retained their respective parcels. If the deceased sibling's trust was a 'related party' under section 1031, the exchange of the interests for the whole parcels could have been found to be a taxable event to the other two siblings due to nonn-compliance of the two year-rule reference above.

Although her trust sold within two years of the swap in ownership, the IRS said the sale did not trigger tax on the exchange by the other two trusts. The ruling held that the exchange and subsequent sale was not a transaction to which section 1031 applies because the sibling taxpayers are not related to the Trust within the meaning of section 1031.

This ruling provides some insight into who is NOT considered a Related Party within the context of 1031 exchanges. However, rules on related parties should be reviewed with your tax professional before relying on any Private Letter Ruling for definition. You may also give us a call at 888-367-1031 if you have any questions regarding 1031 exchanges between related parties.