Can You Do a 1031 Exchange With a Family Member?

You can do a 1031 exchange with a family member, but the IRS layers extra rules on top of the normal like-kind exchange requirements. The most important one is a two-year holding period: both you and your relative must keep the properties you received in the swap for at least 24 months, or the entire tax deferral collapses and the gain becomes taxable.¹ A second rule blocks any exchange structured to shift tax basis between family members or let one of you walk away with cash. Both rules exist because relatives could otherwise use exchanges to move gain around inside a family or cash out of appreciated real estate tax-free.

Which Relatives Trigger the Related Party Rules

For 1031 purposes, a related person is anyone described in Section 267(b) or Section 707(b)(1) of the Internal Revenue Code.¹ Section 267(c)(4) defines “family” narrowly:²

Your spouse
Parents, grandparents, and other ancestors
Children, grandchildren, and other lineal descendants
Brothers and sisters, whole or half blood

Aunts, uncles, cousins, nieces, nephews, and in-laws are not on this list. An exchange with any of those relatives is treated the same as an exchange with a stranger, and the two-year holding rule does not apply.

The definition also reaches entities. A corporation in which you own more than 50 percent of the stock counts as a related party, as does a partnership in which you hold more than 50 percent of the capital or profits interest. Trusts and their fiduciaries and beneficiaries can also fall inside the definition.² Identify every one of these relationships before you structure the deal, because miscategorizing the other party can wipe out the deferral.

The Two-Year Holding Period

When the other party is a relative, both of you have to hold the property you received for at least two years. The 24-month clock starts on the date of the last transfer in the exchange and runs continuously.¹ If either side sells, gifts, or otherwise disposes of the property before the two years are up, the deferral is revoked and the original gain becomes taxable in the year of the early disposition.

Something short of a sale can also break the period. If either party enters an arrangement that substantially reduces the risk of loss on the property, such as a put option, a short sale, or granting someone else the right to acquire it, the holding-period clock is suspended while that arrangement is in place.¹ Refinancings, title changes, or creative deal structures during the 24 months deserve careful review before you sign.

What Breaking the Holding Period Costs

If the two-year rule is violated, all the deferred gain snaps back into your taxable income. Federal long-term capital gains rates run from 0 to 20 percent depending on your total taxable income.³ If your modified adjusted gross income exceeds $200,000 for single filers or $250,000 for joint filers, the 3.8 percent Net Investment Income Tax applies to some or all of the gain on top of that.⁴

Depreciation makes the bill worse. Any gain attributable to depreciation you claimed while you held the property is unrecaptured Section 1250 gain and is taxed at a maximum rate of 25 percent.⁵ State income tax may apply too. In higher brackets the combined hit on the appreciation can exceed 30 percent.

The IRS may also add a 20 percent accuracy-related penalty on the underpayment if the failed exchange produced a substantial understatement of income tax, plus interest running from the original return’s due date.⁶ Treat the 24 months as a firm deadline.

The Three Narrow Exceptions

Section 1031 recognizes only three situations where an early disposition does not blow up the exchange:¹

Death of either party. A transfer through the estate does not disqualify the exchange, and heirs generally take a stepped-up basis equal to the property’s fair market value at death, which can effectively erase the deferred gain.⁷
Involuntary conversion. Destruction by natural disaster, condemnation through eminent domain, or a similar event outside the owner’s control is excused, but only if the exchange occurred before the threat existed.
No tax-avoidance purpose. You can seek relief by showing that neither the exchange nor the early disposition was primarily aimed at avoiding federal income tax. This requires documentation of the real business or personal reasons for selling early, and the IRS has to accept the explanation.

There is no hardship exception outside those three. No extension is available.

The Ban on Basis Shifting and Cash Outs

Holding the property for the full two years is necessary but not sufficient. Section 1031(f)(4) strips deferral from any exchange structured to avoid the purposes of the related party rules, meaning the deal cannot be a vehicle for shifting tax basis between relatives or letting one of you cash out tax-free.¹

Revenue Ruling 2002-83 lays out the classic prohibited pattern. A taxpayer transfers a low-basis property to a qualified intermediary, who sells it to an unrelated buyer for cash. The intermediary then uses that cash to buy the replacement property from the taxpayer’s relative. The taxpayer ends up holding new property with deferred gain, and the relative walks away with the cash. The IRS treats the arrangement as a disguised related party exchange and denies deferral.⁸ Routing the deal through an intermediary or extra buyers does not fix it. The agency looks at the end result, not the choreography.

Boot Is Riskier Between Relatives

A 1031 exchange defers tax only on the like-kind property you receive. Anything else you get out of the deal is “boot” and produces immediate taxable gain up to its value. Boot typically shows up two ways:

Cash boot. Money used to equalize property values, or any sale proceeds you pull out instead of rolling into the replacement property, is taxable.
Mortgage boot. If the debt on your replacement property is smaller than the debt on the property you gave up, the difference is treated as boot unless you add cash to offset it. Trading a property with a $300,000 mortgage for one with a $200,000 mortgage produces $100,000 of debt relief.

In a family exchange, boot creates extra danger. If your relative ends up with cash while you take the replacement property, the IRS can recast the whole arrangement as a disguised cash-out under the basis-shifting rules.⁸ Structuring the deal so that neither side takes meaningful boot is the safer path.

Form 8824 for Three Tax Years

You file IRS Form 8824 with your return for the year of any like-kind exchange. When the other party is a relative, that reporting continues for two more years. You file Form 8824 again in each of the two tax years after the exchange to confirm that both you and the related party still hold the properties.⁹

In the follow-up years you complete Parts I and II. If nobody disposed of the property that year, nothing further is required. If either side did dispose of it and no exception applies, you complete Part III and report the previously deferred gain as taxable income for that year.⁹ Skipping these follow-up filings can draw scrutiny even when the underlying exchange was clean.

1
Office of the Law Revision Counsel. 26 USC 1031 – Exchange of Real Property Held for Productive Use or Investment
2
Office of the Law Revision Counsel. 26 USC 267 – Losses, Expenses, and Interest with Respect to Transactions Between Related Taxpayers
3
Internal Revenue Service. Topic No. 409, Capital Gains and Losses
4
Internal Revenue Service. Topic No. 559, Net Investment Income Tax
5
eCFR. 26 CFR 1.453-12 – Allocation of Unrecaptured Section 1250 Gain
6
Office of the Law Revision Counsel. 26 USC 6662 – Imposition of Accuracy-Related Penalty on Underpayments
7
Office of the Law Revision Counsel. 26 USC 1014 – Basis of Property Acquired from a Decedent
8
Internal Revenue Service. Rev. Rul. 2002-83
9
Internal Revenue Service. 2025 Instructions for Form 8824 – Like-Kind Exchanges