Key Insights on How Long to Hold Property Before Selling in a 1031 Exchange
When considering a 1031 Exchange, it’s essential to understand the rules and regulations to ensure compliance and maximize tax benefits. A common question is regarding how long a property must be owned (held) before it can be sold if the taxpayer desires to structure the sale as a 1031 Tax Deferred Exchange.
1031 Exchanges can only be utilized by investors and not dealers or flippers. What is commonly referred to as the “two-year rule” often confuses taxpayers since it applies to different scenarios. Understanding these differences may help investors navigate these often misunderstood 1031 concepts.
2 Year Rule: Holding Property
Many think the “2 year holding rule” for a 1031 Exchange is a formal requirement. It is not unless the buyer and seller are related parties. While holding a property for at least two years may help demonstrate the taxpayer’s intent to hold the property for investment, the IRS does not mandate a specific holding period.
2 Year Rule: Related Party Transactions
If you exchange property with a related party, both parties must hold their respective properties for at least two years following the exchange. If either party disposes of the property within this period, the exchange may be disqualified, and the tax deferral may be disallowed by the IRS. Read more here.
1031 Is All About Intent
Intent is a fact and circumstance test involving several factors. How long the property was held by the taxpayer prior to sale or after it was purchased, is only one factor to consider. Other factors that the IRS looks at to determine the presence (or absence) of a qualified intent include:
1. The frequency and number of real estate transactions entered into by the taxpayer
The more property sales a taxpayer has, the more likely the IRS may find that the taxpayer is a “dealer,” that the property is “held primarily for sale,” and does not qualify for exchange treatment. An example is the investor who buys foreclosed/distressed properties, fixes them up and then immediately attempts to “flip” for a quick profit.
2. The development activity of the taxpayer
This includes the taxpayer’s activities, such as subdividing the property, adding streets, roads, sewers, utility services, rezoning and renovating the property. The IRS looks at the extent that the gain on the sale of the property was attributable to the taxpayer’s own efforts relative to the property as opposed to a gain due to external factors. Subdividing a property will not necessarily prevent a taxpayer from receiving exchange treatment on the disposition of the property, but the development activity may.
3. The nature and extent of efforts by the taxpayer to sell the property
Sales efforts of the taxpayer, such as advertising, use of sales personnel, a sales office to sell individual lots in a subdivision, or listing with and delegating sales activities to a broker, will be reviewed to determine the proportion of the Exchanger’s income that is derived from the sale of the property, and the extent of the taxpayer’s involvement, time, effort and control over the sales activities regarding the property.
If the taxpayer’s intention at the time of purchase was to hold the property for investment purposes or for productive use in the taxpayer’s trade or business and was not intended “primarily for sale,” a 1031 Exchange treatment may qualify. For instance, if an investor buys a building with the intention of holding it for investment and receives an incredible unsolicited offer a few months later, that transaction may qualify for 1031 tax deferral treatment. Be aware that most properties owned by developers, builders and rehabbers generally are considered to be held “primarily for sale”. The IRS looks at the intent of the investor/taxpayer in each situation.
Taxpayers are always advised to consult with their tax and legal advisors regarding the exchange status of a property.
We, at IPX1031, pride ourselves on not only being an industry leader in expertise, service and security, but we also strive to help our clients and their advisors keep current on tax issues pertaining to §1031 Exchanges and applications for them. We aim to be your complete information resource. For more information about us, our complimentary webinars about 1031 Exchanges, or to initiate an exchange, visit our website at www.ipx1031.com