In today’s fast paced Investment Real Estate Market properties can be sold quickly whether you are marketing a property or simply receive an unsolicited offer. Investors often ask how long a property must be held to qualify for a 1031 Exchange and the answer is simply It Depends… Intent is much more than time and the following will elaborate on this topic.
Did You Know it’s not the length of time a property is held that determines the nature of investment?
Property that is acquired primarily for sale is not eligible for exchange. It seems the distinction between property held primarily for sale and property held for investment is not that great since the purpose of acquiring investment property is almost always to sell it at some point in time, and hopefully for a large profit!
Many investors that buy and sell real estate want to know when they are crossing the fine line from being an investor to becoming a dealer. It is one of the “gray areas” of Section 1031. A dealer can have properties that he uses for his business, but he is also entitled to be an investor like anyone else. The best source of guidance that can be pointed to are 9 points that the tax court used to determine “Dealer Status” in the Klarkowski court case (Klarkowski v. Comm. TC Memo 1965-328, affd 385 F.2nd 398, CA7 1962). The following 9 points can help an investor determine whether they fall into dealer category.
- The purpose for which the property was acquired.
- The purpose for which the property was subsequently held.
- The extent of improvements made.
- The frequency, number, and continuity of sales.
- The extent and nature of transaction in the property.
- The ordinary or general business of the taxpayer.
- The extent of advertising and promotion for sale.
- Whether the property was listed with a property broker or other outlets.
- The purpose for which the property was held at the time of sale, as apposed to the time of acquisition.
Although the Klarkowski case occurred in the mid sixties the rationale seems to be reliable even today. In Patrick A. Reesink et ux. v. Commissioner (Patrick A. Reesink et ux. v. Commissioner; T.C. Memo. 2012-118; No. 2475-10), the taxpayer’s attempt to rent a replacement property for several months before subsequently giving up, selling their personal residence, and finally moving into the replacement property satisfied the requisite intent to hold for productive use in trade or business or for investment as requirement under IRC 1031.
The IRS does realize that people’s circumstances may change; therefore, it is possible for a property to change in character overtime. Your primary residence could become an investment property or rental house may become a primary residence. It is possible that a property that was originally acquired to fix up and sell could later become a rental and therefore be considered investment property. The taxpayer’s intent is typically much more important than even the length of time the property is held.
So while your property does not currently qualify for an exchange, with time and proper planning, it could qualify in the future. For additional information on this topic or to speak with an exchange counselor call Equity Advantage today.
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