As an investor, 1031 exchanges are an excellent tool for maximizing your return. The rules can be complex, however, and timing is important as well. Educate yourself, and if you’re considering a 1031 exchange, get a team of professionals on your side. Read on to find out what sort of properties can qualify for a 1031 exchange.
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What Rules Govern Whether a Property Qualifies for 1031 Exchange?
When we’re talking about qualified money, IRAs, 401(k) plans, it’s really not much different than what you’re talking about with 1031. We’ve got a couple of changes there, but the bottom line is with a retirement account, whatever you’re buying has got to be an investment property. There can’t be any personal benefit.
When we’re looking at 1031, we’re talking about, once again, property that has to be acquired with the intent to hold for investment, and property that was relinquished after being held for investment. A lot of times that comes up, and someone says, “Well, define ‘real property held for investment.’ How long does it have to be held?” There’s really no stated minimum black-and-white hold period in the code. People often say two years. There’s a two-year related-party transaction rule, and even that doesn’t apply 100 percent of the time because if you can document there’s no intent to avoid the tax, even with a related-party transaction, that two-year period might not be required.
But we’re looking at an arm’s length, third-party transaction. There’s no stated required hold in the code, so we’re really looking at just intent. You gave up property you’ve held for investment. You’re acquiring property with the intent to hold for investment. That investment property could be land or a place at the beach you would be retiring to someday. It could be office buildings or strip malls. It just refers to the nature of the investment rather than the form.
If you are operating in the typical investor M.O., the first investment house is maybe a home you grow out of, and then turned into an investment. And then you roll that into a plex, roll that plex into that bigger plex, into the multifamily project. Then you end up getting tired of the toilets, trash, tenants, turnover. You end up buying industrial stuff or commercial. Maybe it’s a strip mall or office building. Then at the end of the game, maybe you’re looking at, “Gee, I’m tired of all this. I just want a place to park the money, and I don’t want to have to pay the tax.” So you end up winding it down with a DST, Delaware Statutory Trust, or a tenancy in common investment, even an UPREIT. So people want to know, “Can I exchange into a REIT?” It’s a qualified “yes.” If that REIT sponsor has what is called an UPREIT, that would qualify. My concerns about REIT transactions is you can get into them with total tax deferral, but there’s no way to get out without paying tax.
Does your property qualify for an exchange? Well, even a home could qualify. You have to look at what a property is at the time you decide you want to sell it, and what you really want it to be. Keep in mind that a primary residence falls under Section 121, the universal exclusion, and it gives you a $250,000 exclusion individually or a half million on the sale of a primary residence—for a property that’s been lived in for two out of the preceding five years. That rule came into play in 1997. Those numbers, 250 or 500K, made sense to a lot of people in those days, but today gains can be well beyond that.
People often come to us about that. They say, “Well hey, my gains are in excess of the 250 or 500. I don’t want to pay the tax.” And we say, “Move out of the property. Season it as an investment.” Then after a period of time that’s agreeable to you and your tax people, you relinquish the property using 1031. You’re still entitled as long as you sell within three years of moving out to the 250 or 500K. The overage would go into the exchange, and you can in effect defer everything. On the other hand, you say, “Hey. I don’t want income properties anymore. I’m tired of, once again, the Terrible Ts. I want to go buy the place at the beach.” Could you do that? Could you move into it?
The answer once again is “yes,” and it’s just solely a question of how long you need to hold it prior to moving into it. Once again, there’s no hard number there. It’s up to you and your tax people. So anytime we’re looking at these gray areas, it’s critical to include your tax counsel in the decision. My experience after doing this for almost 30 years is that most of the time tax and legal people like to know about these transactions before April 15. Use the resources you have. Take advantage of your tax people. They would really appreciate it, and it’s going to help you out. Start talking about these things when you’re doing year-end planning.
Look at any gains and losses you might have, and work with those people because they’re going to make a difference in your life. But as far as property that can qualify for 1031, virtually anything can, and it’s just a question of whether you want to make it fit or not. Then we’re really just talking about seasoning periods to justify that transaction.
1031 exchanges are complex. Using an exchange accommodator like Equity Advantage puts a professional in your corner who knows all the rules. It just takes a phone call to get started: 503-635-1031.