While much of the tax code is scrutinized under objective factors, the IRS likewise looks to subjective factors in determining whether an exchange soundly falls under section 1031 of the tax code. This applies to the requirement that only real estate property held for productive use in a (i) trade or business or (ii) for investment qualifies under the section 1031. This is known as the “held for” requirement. The held for requirement applies to all exchanges, whether fully deferred or partially deferred, and is twofold:
The first consideration is that of the property category (trade, business or investment).
The second consideration is that of timing.
It is this timing consideration that can prove difficult for some exchangers as the IRS looks to the subjective facts and circumstances of the exchanger.
The IRS is primarily concerned with the intent of the investor. While intent can be difficult to prove, some generalities hold. For example, property held out for investment is not property bought with the intent to quickly sell as in the case of “flipping.” The IRS categorizes an investor flipping homes as a “dealer.” But the timing requirement beyond this can still be a grey area. Most tax advisers agree that property held for less than a year before exchanging does not move one out of the “dealer” category. Advisers are split as to whether 1 to 2 years is enough. Some take the more liberal approach that one tax filing season will suffice, while others suggest that 2 years is best. Most CPA’s consider at least 2 years as enough to meet the timing requirement. Please note, however, that there may be cases where even 2 years is not enough if the tax adviser considers that the investors bona fide intent does not match the IRS requirements. We always suggest exchangers consult their tax counsel in determining this.
This timing requirement applies to both the relinquished and replacement property. Exchangers must meet the timing requirement before exchanging relinquished property. Many exchangers additionally question how long they must hold on to replacement property before they can sell it again, or change the property use (i.e. from investment to personal). The answer to this question is: “it depends.” Due to the subjective and context driven nature of the analysis, we at CR Capital 1031 err on the side of a more conservative approach. However, we do not determine the ultimate answer. Our role is to facilitate the exchange and keep the exchanger appraised of any legal and tax implications when applied to the facts at hand. Therefore, it is ultimately up to the exchanger and their adviser to structure the exchange and maintain the subsequent intent requirement after the exchange is complete.
CR Capital 1031, LLC does not provide tax or legal advice, nor can we make any representations or warranties regarding the tax consequences of your exchange transaction. Exchangers must consult their tax or legal advisors for advice and clarification on tax rules.