If a taxpayer engages in a like-kind exchange with a related party, the taxpayer qualifies for gain deferral under IRC Section 1031 only if the related party holds the property that it acquired from the taxpayer for at least two years. In Teruya Brothers, Ltd. v. Commissioner, the taxpayer unsuccessfully attempted to use a qualified intermediary to make an end run around this rule. Most exchanges are completed through qualified intermediaries because the use of an intermediary allows a taxpayer to sell his current property and have the intermediary hold the funds for a short period of time while he locates a replacement property to purchase.

In this case, the taxpayer transferred property to an intermediary which sold it to an unrelated third party. At the taxpayer’s direction, the intermediary used the resulting funds to purchase a replacement property from a party related to the taxpayer (“Times”). If the taxpayer had instead transferred its property to Times in exchange for Times’ property, Times’ sale of the taxpayer’s property within two years would have disqualified the transaction from Section 1031 tax free treatment. The Tax Court held, and the Court of Appeals for the Ninth Circuit agreed, that the taxpayer cannot change this result by running its transactions through a qualified intermediary. Times did not hold the taxpayer’s exchanged property for two years (or at all for that matter) so the transaction ran afoul of the related party rule.