Property Held for Sale Does Not Qualify for 1031 Exchange Treatment

This is an area that always confuses and frustrates investors. Most investors believe they acquire real estate as an investment. They intend to make a profit. Why else would they buy real estate? However, the IRS defines held for investment much differently for 1031 tax deferred exchange purposes than what many real estate investors might realize.

Held For Sale vs. Held for Investment

The Internal Revenue Service differentiates between buying and holding real estate for investment versus buying and holding real estate for sale. It can be a very fine line in certain circumstances, but it can mean the difference between a successful 1031 tax deferred exchange or a disallowed taxable sale.

Intent To Hold for Investment

Here is how you can tell if you will qualify for 1031 tax deferred exchange treatment. It really boils down to your intent. Do you have the intent to buy and hold the real estate for investment? Or, do you have the intent to buy the real estate and then sell or flip relatively quickly? Are you buying for a quick flip (quick profit)? Are you buying specifically to fix-up and then sell? Are you buying apartments to convert to condos and then immediately sell? Or, are you going to buy and fix-up and then hold or convert and then hold as rentals? The bottom line is can you demonstrate and show that you did in fact have the intent to hold your real estate for investment if you get audited?

Holding Period for 1031 Tax Deferred Exchange Property

We are often asked how long an investor must hold the property in order to demonstrate their intent to hold and therefore qualify for 1031 tax deferred exchange treatment. There is no black and white answer for this question. The Treasury Regulations require that you have the intent to hold for investment, but the Treasury Regulations do not define intent.

This is why you will hear many different opinions as to how long you must hold the property: 12 months, 12 months and a day, 24 months, straddle two tax years, etc.  We recommend that you buy and hold the property as rental, investment or use in your business for at least 12 months because it clearly demonstrates that you had the intent to hold for investment and it also straddles two income tax returns. 

Property Held as Inventory

Real or personal property that is held for sale or resale is considered inventory in the investor's trade or business (i.e. held for sale) and will not qualify for 1031 tax deferred exchange treatment.  This includes some of the examples of real property used above, but also includes inventory held for sale such as homes built by a developer, food products sold in a store or restaurant, etc.

Dealer or Investor

The courts have been asked many times to assist in cases like this.  Here are some of the factors they use in determining whether  the seller is a dealer (property held as investory in his or her business) or whether he or she is an investor and entitled to qualify for 1031 tax deferred exchange treatment:

• the original intent of the investor when he or she acquire the property; or
• the length of time that the property was held by the investor; or
• whether the investor has engaged in developer-dealer activities such as building in the past; or
• how the property was used while it was held by the investor; or
• changes with respect to the property or the investor's economic or personal circumstances; or
• improvements made to the property, and the time that the improvements took; or
• whether investors have entered into any sales agreement; or
• whether the property was rented, and the length and terms of such lease agreement; or
• whether the replacement property is disposed of, divided, or the investor otherwise shows that his or her intent in acquiring the replacement property is for purposes other than investment or business use.