If you do a search of the internet for “five year hold and the 1031 exchange”, there are many responses talking about this hold period. The truth is, the five year hold is not a requirement of Section 1031, it’s a requirement to prevent you from triggering gain on the disposition of the property that was acquired. Today David Moore talks about what the five year hold really is.
In 1997, when Section 1034 (the exclusion for the sale of primary residence) was replaced with Section 121 (the universal exclusion) there was a brief window of time where taxpayers could acquire a property via 1031 Exchange, hold it a year or so, convert it into a primary residence living in it for the required 2 years followed by an immediate sale. However the government saw themselves losing too much money and put in place the American Jobs Creation Act (H.R. 4520), which made any sale acquired via 1031 and held for primary residence result in a fully taxable sale. The five year hold slowed the governments loss of tax revenue, and in 2008 with the Housing Assistance tax act, the opportunity was for the most part closed.
David Moore: Hello. David Moore with Equity Advantage, 1031exchange.com. And I’m going to address a couple of different questions today, things that we get asked a lot, and some of them are a little puzzling. But the first one I’d like to address is the term “Five-year hold on 1031.” And there’s lots of you out there searching that term, and it was really sort of a funny thing because it’s not something that typically is looked at in a 1031 context, but it is a combination of things. If you’re exchanging into a property, using 1031, you exchange into a property that ultimately is converted into your primary residence.
We can thank the American Jobs Creation Act of 2004 for a five-year required hold net since situation. So what I mean by that is you’re going to buy a property via 1031, and if you were to convert that property from investment into residence, and sell it within a five-year acquisition period, that sale would be fully taxable. So thanks to that Act in 2004, we’ve got a five-year required hold on any property acquired via 1031 and later converted into a primary residence. And that was a result of the change in 1997 from Section 1034 to 121, the old residential rollover to the universal exclusion. And that universal exclusion opened up an opportunity for people to actually take 250 personally, or half million for a married couple. You could do that once every two years on the sale of a primary residence.
David Moore: And for that residence to qualify, you only had to have lived in it for two out of the preceding five years. So if you look at it in 1031 context, you’re going to be giving up a property, you acquire new property. Maybe you hold it, let’s say for a year or so, whatever you and your tax people feel is a reasonable period of time. You move into it. And between, like I said, 1997, 2004, we had lots of people saying, “Hey, this is a great idea. We’re going to acquire this thing, hold it a year, move into it, live in it two, dump it after three years, and take the 250 or 500. Now we can just do it over and over and over again.” And old Uncle Sam saw that happening, decided they’d seen enough.
And so thanks to that Act in 2004, we now have a five-year required hold. That does not mean that you can’t do it. So any time we have a rule, I like to say it’s sort of a double-edged sword. We have a rule that ties us down to five years, but we also have a rule that ratifies the process. They’ve said, “Hey, you can do this.”
David Moore: So yeah, that timeline, I know it’s inconvenient and it does slow things down dramatically, but it did give you the ability to ratify the process, actually. Now, if we fast forward a few more years, we’ve got the Housing Assistance Tax Act of 2008.
Now, why people search the five-year hold on 1031 more than the Housing Assistance Tax Act is beyond me, because the Housing Assistance Tax Act of 2008 is much, much, much more damaging than that five-year hold. And you just gotta love the name of it, Housing Assistance Tax Act. Sounds like it’s there to help us, and really, it just sticks it to us. So really, in a nutshell, what it says is, “Yes, you can convert that investment property into a primary residence. You need to hold it for no less than five years.”
David Moore: And then, just keep this in mind, you’re never going to see the full 250 or 500. You’re going to get prorations that 250 or 500. The prorations that you’re allowed, they are attributable to the amount of gain that’s attributable to qualified versus non-qualified use periods.
So your next question is, “Well, what’s a qualified use or a non-qualified use?” Well, the qualified use would be the time you lived in it. The non-qualified use would be the time that was held as an investment. And they tightened it up to April of ’09, so the gain from ’09 to the date of conversion, that’s non-qualified use. The time from the data conversion to the date of disposition that you’ve lived in it as a primary residence is a qualified use, so you’re going to blend those two ratios. And as with everything in the tax world, it’s a convoluted formula and confusing to people. So talk to your tax people about it. I know you’ve got great ideas out there. You’re going to get rid all the gain with the 250 or 500 after conversion, and that’s just… It doesn’t work any longer.
David Moore: We’ve got another video, and that sort of spells out a little bit longer. But once again, I just wanted to sort of demystify the five-year hold since lots of you are searching five-year hold section 1031. And it really truly is only applicable to a property that’s acquired via 1031, converted to a primary residence, and then later sold. So again, if you sell a property that’s acquired via 1031 converted inside five years, it’s a fully taxable sale. After the five years, you’re going to be subject to the Housing Assistance Tax Act of 2008. So one last thing to think about.
I’m laughing about it, because we’ve got the Housing Assistant Tax Act, and it sounds like it’s really going to help you. And then we had the American Jobs Creation Act in 2004, and how often does the government actually create jobs? Seems like they just stick it to us and slow things down.
David Moore: But hope this has been helpful. David Moore, Equity Advantage, 1031exchange.com. And please don’t hesitate to reach out with any questions or concerns you may have. And if you’ve got an idea for a topic you’d like presented in this format, we’d be happy to accommodate that. Please reach out to see more at 1031exchange.com, and she will address any questions, concerns or needs you may have. Take care, and look forward to speaking soon. Bye-bye.
David and Thomas Moore, the co-founders of Equity Advantage & IRA Advantage
