Exchanging property with a related party is allowed under Section 1031, but it comes with a condition that trips up more exchangers than any other part of the related-party rules: both the exchanger and the related party generally have to hold onto their respective properties for at least two years after the exchange closes. Dispose of either property before that two-year mark and the deferred gain from the original exchange can be recognized retroactively, as if the exchange had never qualified.
This provision exists specifically to prevent a narrow kind of abuse, where related parties swap high-basis and low-basis properties to shift tax liability without any real change in economic ownership, then sell shortly afterward.
Who counts as a related party
Section 1031(f) borrows its definition of related party from Sections 267(b) and 707(b) of the tax code. That definition includes immediate family members such as spouses, siblings, and lineal descendants or ancestors, along with entities in which the exchanger holds more than a 50% ownership interest, and two entities under common control above that same 50% threshold. It does not include more distant relatives such as cousins, in-laws, or aunts and uncles, who fall outside the related-party definition entirely.
How the two-year clock works
The two-year holding period runs from the date of the exchange, and it applies independently to each party. If the exchanger's related party sells their newly acquired property 18 months after the exchange, the exchanger's own deferred gain can be recognized in that year, even though the exchanger has not sold anything and has no control over the related party's decision. This creates a real, ongoing dependency between two taxpayers that many exchangers do not fully appreciate until well after closing.
Exceptions to the two-year requirement
The rule includes several carve-outs. A disposition caused by the death of either party does not trigger recognition. An involuntary conversion, such as a property lost to condemnation or a casualty event, is also excepted. There is also a general exception where the exchanger can demonstrate that neither the exchange nor the early disposition had tax avoidance as a principal purpose, though relying on this exception without strong documentation is a difficult position to defend if the exchange is examined.
The parking-then-cashing-out trap
A frequent structure that draws IRS scrutiny involves an exchanger selling relinquished property to an unrelated buyer, then buying replacement property from a related party who, in turn, receives cash and effectively cashes out of a low-basis asset while the exchanger picks up a stepped-up basis property. This kind of structure, even without a direct related-party swap, has been challenged in court cases as functionally circumventing the two-year holding requirement, and it warrants careful review before it is used.
Documenting a related-party exchange properly
Because a related-party exchange invites more scrutiny than an arm's-length transaction, the documentation supporting it matters more, not less. That includes an appraisal or other independent evidence supporting the fair market value used in the exchange, a clear record of the business or investment purpose behind the transaction, and a written understanding between the parties about the two-year holding commitment each is making. Exchangers who treat a related-party exchange the same as any other, without building this documentation trail, are the ones most exposed if the transaction is later examined.
Common 1031 Exchange Questions
Can you do a 1031 exchange with your sibling?
Yes, but the exchange is subject to the related-party rules, meaning both you and your sibling generally need to hold the properties received for at least two years, or the deferred gain can be recognized retroactively.
Does the two-year rule apply if you buy replacement property from a related party without a direct swap?
Yes, if the parties are related under Section 267(b) or 707(b), acquiring replacement property from that party in an exchange triggers the same two-year holding requirement, not just a direct property-for-property trade.
What happens if your related party dies before the two years are up?
Death is one of the recognized exceptions. A disposition caused by the related party's death does not trigger recognition of the previously deferred gain.
Do cousins or in-laws count as related parties?
No, the definition under Sections 267(b) and 707(b) covers spouses, siblings, and lineal descendants or ancestors, along with commonly controlled entities, but does not extend to cousins, aunts, uncles, or in-laws.
Can an LLC you own more than half of be a related party in an exchange?
Yes, an entity in which the exchanger holds more than 50% ownership is treated as a related party for purposes of these rules, whether it is an LLC, corporation, or partnership.
