1031 Exchange
Hello all,
2 Q's regarding 1031's.
First, say I buy a house,new or used, and flip it for $x profit in under 2 yrs. Then I take the $x profit and do a 1031 exchange on another house. I then live in the '1031' house for 2 yrs. and then sell it. Will I have to pay the capital gains on the sell of the '1031' house ?
Second, say I sell more than one house in a short period of time. Can I roll the $x profits from the sell of multiple homes into one home that is of greater value than any of the other single homes ?
Thanks!
Quote:First, say I buy a house,new or used, and flip it for $x profit in under 2 yrs. Then I take the $x profit and do a 1031 exchange on another house. I then live in the '1031' house for 2 yrs. and then sell it. Will I have to pay the capital gains on the sell of the '1031' house ?Your primary residence is not eligible to participate in a 1031 exchange. In this scenario, the exchange will be disallowed, and the $x profit from the sale of your first property becomes taxable.
Quote:Second, say I sell more than one house in a short period of time. Can I roll the $x profits from the sell of multiple homes into one home that is of greater value than any of the other single homes ?1031 exchange can only be used for investment property or business use property. If all of the properties that you are selling in a short period of time are eligible to participate in a 1031 exchange, then you are free to lump all of your "relinquished" properties under a single exchange umbrella. For example, you have five investment properties you want to sell so you can reinvest the proceeds into an apartment building.
As long as the purchase price of the apartment building is greater than or equal to the combined sale price of the five relinquished properties, you have a non-taxable exchange. Of course, the timing is important. You must sell all properties quickly, and complete the replacement property acquisition within six months of the settlement date on the first relinquished property.
Now, if your question is really about rolling several sequential exchanges forward in a short period of time, then I would think that the IRS would consider that you never intended to hold the replacement properties for a qualified investment use and disallow all the exchanges.
Thanks for the reply !
So, you have to hold on to a property for a period of time before it is acknowledged by the IRS AS AN investment property in order to do a 1031 exchange to purchase another investment property ? How long is this period of time ?
Thanks again !
It isn't a specific holding period that is important here, it is how you actually use the replacement property.
If you put it in service as a rental then your replacement property is being used for a qualified purpose. Most advisors suggest using the replacement property for a qualified use at least one year. I have seen a Robert Bruss article that suggested six months might be adequate. However, continue the sequential exchanges and the IRS will look at the form and substance of the entire series of transactions to determine whether your true intent was to use the property for a qualified investment use in the first place. If the IRS determines that your strategy is just a tax avoidance scheme with no real business purpose, they will disqualify the exchange(s).
Perhaps Bill Exeter should contribute here. He seems to be better versed in the exchange process and the IRS ramifications of getting it wrong.
I'd recommend you call & chat with one of the 1031 specialist companies, such as Starker Exchange Services, which is not only national, but was the father of ALL 1031 law...and I've found they know their business very well & give good service.
And, very important, they're glad to answer your questions upfront, at no charge, so you know the answers upfront and exactly what you're getting into.
I certainly have no monetary interest in Starker, no referral fees, just like them and the way they do business.
[addsig]
There are a ton of 1031 exchange companies around. I personally use:
http://www.ipx1031.com/index.html
You can learn a lot just by perusing their site.
Anyway, I think you are getting two concepts mixed together. If this is your primary residence, you must live in it for 2 of the last 5 years. However, if this is an investment property that you are wanting to flip, I don't beleive there is any holding period required. I have done a 1031 exchange in < 3 months. The time constrints with 1031 come into play in that you have to determine what property will replace the one you sold in so many days, and actually buy it in so many days. I am afraid to quote the days, but you will find it on the site listed above.
Good Luck!
You can do a 1031 exchange after holding a property for a short period of time. I checked this out with a qualified intermediary last year. The IRS is likely to frown a sequence of decendant 1031 exchanges.
You can definitely exchange more than one property for a single property. The issue will be on the timing. You must declare the "replacement property" within 45 days of sale and you have 180 days from date of sale to complete the purchase of the replacement property.
There is a lot of mis information in this post, so please be careful.
First of all, you CAN combine Section 1031 with Section 121 of the IRC. For example, you could buy a house and rent it or hold it as investment property and then sell it and do a 1031 exchange into another house. In order for this property to qualify for 1031 exchange treatment it would also have to be rented out or held for investment for a period of time (more on the holding period in a moment). I would recommend at least 12 months. Then you would move into the home and convert it to your primary residence. Once you have lived in the house for 24 months you can sell it and exclude up to $250K in capital gains if you are single and up to $500K if you are married and filing a joint income tax return (only the capital gain would be excluded, the depreciation would still be recaptured and taxed at 25%).
Yes, you can sell multiple properties and exchange into one property. There are a couple of ways to structure the 1031 exchange transaction depending on the transaction details. The general rule is that you must exchange into property that is of equal or greater value than what you sold and you must reinvest 100% of your cash/equity.
Now for intent and holding period. Some of the comments posted here are wrong and concern me. There are numerous cases in which the taxpayer held his property for less than 12 months and the 1031 exchange was disallowed by the IRS. Holding property for less than 12 months IS taking on some risk. The shorter the time frame the more risk. Flipping property immediately clearly does not qualify. For more information, refer to my article posted in TCI at: http://www.thecreativeinvestor.com/modules.php?name=News&file=article&articleid=572. Hope that helps.
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Bill Exeter[ Edited by wexeter on Date 08/06/2004 ]
Thank you ALL for your contribution to my Q's. I appreciate people taking the time to respond ! I'm too new to even BEGIN to pass judgement. Heck ! I'm not easily offended anyway ! Where else can one go and get to pick the brains of the veteran investors ?!!! Again, THANKS to all. I have learned more from this site yet again !
Bill Exeter is president and CEO of a company that specializes in exchanges and his opinions and experiences are well respected. I am adding this for clarification since I did not intend in my post to imply that short holding periods for the relinquished properties will always fly.
In my situation I bought a pre-foreclosure with the intent of leasing back to the former owner, hence making my intent to own as an investment. When the previous owner did not pay I was looking to evict and exchange the property since I did not want to try to find a replacement tenant. My intermediary indicated that since my intent was clearly investment purposes the holding period did not matter. In fact renting to the previous owner was essentially a condition of the sale.
It may be that the difficulty is that the IRS may view a short holding period as evidence that investment is not the intended purpose. In my case I have collateral documentation indicating my intent.
I have found two interesting items that I have included that were in internet 1031 exchange literature.
Section 1031 of the tax code does not provide a defined “holding period” for investment properties. IRC §1031 does specify that a taxpayer must have an “intent” to hold the property for either investment or business purposes to be considered a qualifying “like-kind”
The second addresses exchanges involving parterships and other entities but it is recent, and indicates a trend toward intended use and away from holding period.
IRC Section 1031 requires that both properties in a 1031 exchange be held for investment (or use in business). It does not specify a holding period. However, some tax professionals feel that 1031 exchange property held for less than one year can draw the attention of the IRS. The holding period issue becomes acute when a partnership distributes a property out to its exchanging partners who then promptly engage in 1031 exchange transactions in their individual names. The holding period issue also is raised when an exchanger performs a 1031 exchange and then contributes the new property to a partnership or corporation. There are very good reasons why an exchanger would want to structure a transaction as set forth above. However, the holding period risk sometimes deters the exchanger from structuring their 1031 exchange with a prompt sale after distribution to them or with a prompt contribution after an exchange.
The staff of the Joint Committee on Taxation to the US Congress has recently proposed a simplification of this issue. They propose that the focus be shifted from holding period to use of property. They propose that distributions and contributions from and to partnerships and corporations be ignored as long as the use to which the property has been put remains the same. Essentially the holding period of the entity will be tacked onto the holding period of the exchanger. This proposal would reduce complexity in 1031 exchange transactions by removing the confusion as to whether an exchanger has held the property for sufficient time when the property has been recently transferred. While this report does not represent a change in the law, it provides some comfort level to an exchanger wishing to change the form of entity in which he holds investment real property while doing 1031 exchange transactions.
Bill, I hope that this is in concert with what you were trying to convey.
Regards to all,
Ed[ Edited by edmeyer on Date 08/05/2004 ]
I now understand much more about the 1031. So it boils down to, if I sell a property as a flip, I have no choice but to take the CG hit OR I can roll the proceeds via 1031 into a property in which I keep for a good bit of time ( well over a yr ) as an investment.
Thanks !
Leadman,
I think you missed a key point in the previous posts. You must demonstrate the intent to hold your property for a qualified investment purpose.
Flip property is property held for resale to customers, not for the production of income. In short, flip property is not eligible to participate in a 1031 exchange. Your profit from a flip is taxed to you as ordinary income -- capital gains tax treatment does not apply.
Thanks for the clarification.
I appreciate the help.