Related Party 1031 Exchanges: Evaluating Co-Ownership (CORE) and Tenant-in-Common (TIC) Interests

A 1031 exchange, under Section 1031 of the Internal Revenue Code, allows real estate investors to defer capital gains taxes when selling investment property and reinvesting into like-kind real estate. While exchanges between unrelated parties are common, additional complexities arise when related parties are involved, especially when properties are owned in Co-Ownership of Real Estate (CORE) or Tenant-in-Common (TIC) structures.

This guide explains how IRS rules apply to related party transactions, TIC/CORE arrangements, and the steps investors should take to maintain compliance.

Related Party Rules in 1031 Exchanges

Section 1031(f) imposes restrictions on exchanges between related parties, which include:

• Family members (spouses, parents, children, siblings).

• Business entities with more than 50% common ownership.

• Partnerships and their partners.

The most important restriction is the two-year holding period: both the relinquished and replacement properties must be held for at least two years after the exchange. If either party disposes of their property within that period, the exchange becomes taxable, and deferred gain must be recognized.

Exceptions: The IRS permits exceptions for cases such as the death of a party, involuntary conversions (e.g., condemnation), or when tax avoidance is not the principal purpose.

CORE and TIC Ownership: IRS Treatment

CORE (Co-Ownership of Real Estate)

CORE refers to fractional ownership where each investor holds a direct interest in the underlying property, not just an economic interest. For 1031 purposes, CORE interests are generally considered qualifying real property when:

• Each owner has a true ownership interest (not partnership-style).

• Ownership rights include the ability to partition or transfer interests.

• Income and expenses are allocated proportionally to ownership shares.

In related party exchanges, each CORE owner must satisfy the two-year holding period individually. However, the IRS may aggregate ownership among related parties to assess whether partnership taxation rules apply—especially if a related group holds majority control.

TIC (Tenant-in-Common)

TIC ownership allows multiple parties to hold undivided fractional interests, each with rights to occupy and transfer their share. The IRS outlined key safe-harbor principles in Revenue Procedure 2002-22, including:

• No more than 35 co-owners.

• No entity classification (must avoid partnership treatment).

• Unanimous consent for major decisions like sale or refinancing.

• Proportional sharing of income, expenses, and debt.

• Limited, replaceable property management.

When related parties are involved, TIC arrangements face heightened scrutiny. Demonstrating arm’s-length decision making and observing the two-year holding rule are critical to prevent reclassification or disqualification.

IRS Scrutiny and Risk Factors

The IRS closely examines related party exchanges involving CORE or TIC ownership for substance over form. Red flags include:

• Circular cash flows lacking economic substance.

• Prearranged dispositions within two years.

• Related parties maintaining unified control of both relinquished and replacement properties.

• Transactions structured primarily for tax avoidance rather than legitimate investment purposes.

Compliance Strategies and Best Practices

To strengthen compliance:

• Obtain independent appraisals to confirm fair market values.

• Draft detailed co-ownership agreements outlining rights and responsibilities.

• Maintain separate banking and financing arrangements for each co-owner.

• Keep comprehensive records of negotiations, valuations, and transaction purposes.

• Work with unrelated qualified intermediaries and professional advisors.

• Carefully track the two-year holding period and plan for contingencies like involuntary conversions.

Related party 1031 exchanges involving CORE or TIC ownership can offer significant tax benefits and investment flexibility. However, they demand careful structuring, strict adherence to IRS rules, and thorough documentation. By respecting the two-year holding period, maintaining genuine business purposes beyond tax deferral, and observing arm’s-length practices, investors can preserve the advantages of tax-deferred exchanges while minimizing IRS challenges.

This article is for educational purposes only and does not constitute tax or legal advice. Consult with qualified professionals before engaging in 1031 exchanges or related party transactions.