1031 Exchnage - Help!
I am just about to jump in to the REI investment pool…currently looking for my first rehab. My question is, can I use a 1031 Exchange on a property if I plan to flip the property, fixing it up and selling it ASAP? I have read the IRS tax code that deals with this but have not been able to determine if I have to hold the property for some period of time (say 2 years). I did see a reference that I must “show intent to hold”. Not sure what this means. Has anyone used a 1031 Exchange on a property that was only held for a short time period (1 to 2 months). As I am a newbie to this whole thing I would appreciate any advise.
Thanks,
Rich
If you are flipping property, a 1031 exchange is not available to you no matter how long you hold the property.
A 1031 exchange only applies to property held for investment use or to property used in your business. Flip property is not investment property (according to the IRS definition of investment use property), but instead is dealer realty.
I primarily do 1031 exchanges. I have been audited in the past primarily for business expenses as they pertain to REI. My 1031 exchanges have never been questioned.
I flip with Double Escrows. I own the properties for about 5 minutes. I have not been classified as a Dealer by IRS.
I usually have to use a Accommodator to complete my exchange. My agreements with them is they keep all the interest earned, but lower their fixed fee. This keeps IRS from assuming I have control of the cash.
Taiyo,
All I can say is that you have been very lucky so far. If your flip "exchanges" are ever audited I am sure each one will be recharacterized as a taxable sale of dealer realty with a very big tax hit as a door prize.
I have been Audited from 1990 to 1997 with no questions pertaining to my 1031 Exchanges or Dealer status, I think I am on pretty safe ground. Granted I do not complete as many 1031 Exchanges as in the past (approximately 1 per month). Now I do approximately 1 every quarter.
Due to the Market, my investments are better closed on purchase, to be sold at a latter date with Creative Financing. It is getting difficult to find replacement properties.
I completely agree with Dave. You have been extremely lucky with the IRS.
The Treasury Regulations are very specific in that you must have the INTENT to hold the property for rental or investment. If your INTENT is to flip, you do not qualify.
To answer your question about the holding period, the regulations require that the taxpayer have the INTENT to hold, but they never define the guidelines under which you must hold. Most tax advisors recommend at least one year and to "straddle" two tax years, which means you have two tax returns that report rental income, expenses and depreciation. If you truly do have the intent to hold the property and can prove it then a shorter holding period would be O.K. The problem is that it is very difficult to document and prove your intent in short holding periods.
Just a comment on audits. I have been in the 1031 exchange industry since 1986 and have administered over 50,000 exchanges for clients. The majority of IRS auditors do not know what to look for and many times ignore the 1031 under audit. I have seen many more instances where the Franchise Tax Board in California expands their audit to include the 1031 exchange when they are auditing for other reasons. The IRS is also amending the 8824 form for 2004 which will include language as to when exactly the taxpayer has identified their replacement property identification and to whom they identified it to. They are beginning to try to curb the abuse that exists in the industry.
Wexeter,
I can appreciate learning from one who hs administered this many exchanges.
I have a contract on a house that i bought last October (eight months ago). I have been advertising it as a lease/purchase to potentially get a renter in for a while and hold it longer.
Now I have an offer and waiting for a closing date from her attorney. I really would have rather rented it for a while, but the offer is a good one. I will show approx. $17-$25k profit for 2004 though I had over $9k tax write offs for '03 with NO income, just expenses. If I earn any significant income for 2004, I will be in a different bracket. I need to 1031 this "profit" if possible. Do you think i can establish "intent" if identify other property before I close on this deal?
The fact that you are advertising it as a lease/purchase is a much better position than flipping for 1031 exchange purposes and helps demonstrate your INTENT to LEASE and HOLD the property. I would document your file with copies of the advertising copy and bills/costs paid for the advertising. And, the fact that you would rather rent it out versus sell it (but the offer is just to good to pass up) demonstrates your INTENT to HOLD. And, by the time you close on this sale you will be getting pretty close to a one year HOLDING period. I think you are in a pretty good position to document your INTENT. Identifying potential replacement property before closing on the sale does not create any 1031 exchange issues. I will also send you a link to an article on Holding Requirements via Private Message.
[addsig]
Bill,
Any way the rest of us could get a peek at that article?