'rolling' a 1031 exchange
I have held a 1031 exchanged property for almost 3 years and would like to use it in another exchange. How long must I hold a property before it can be used in an other exchange?
Thanks
JR
The tax code has a 24 month rule for 1031 exchanges, but only if the relinquished property is sold to a related party. In this case, the relinquished property must be used for a qualified investment purpose for a period not less than 24 months, or the 1031 exchange is disqualified and the relinquished property sale is recharacterized as a taxable transaction.
The tax code is silent on the question of how long an investment property acquired in a 1031 exchange has to be held before it can be used as the relinquished property in another 1031 exchange. I suggest that the taxpayer use the 24 month related party rule as a precedent here, and hold the acquired property for investment use for at least 24 months. More aggressive tax advisors suggest at least 12 months of investment use, and the most aggressive suggest at least six months of investment use; but, none (that I have read) suggest that the acquired property can be immediately used in another 1031 exchange
Thanks for the advice.
The issue here is whether the IRS will assert the "step transaction doctrine." In other words, will they step the exchange of the previous property together with the exchange of the new property. For an exchange to qualify under Section 1031, the property must be held for a trade or busines or investment purposes. If you purchase a property and exchange it into replacement property and then shortly thereafter enter into another exchange, if the "shortly thereafter" is close enough in time the property property will not have been held for business or investment purposes and the exchange will be disqualified.
A review of most caselaw indicates the IRS is usually successful in litigation when the "shortly thereafter" period is less than 1 year. How much more than one year is necessary? That will depend on your specific facts. What I can tell you is that the normal statute of limitations on tax return items is 3 years (however, there is a 6 year SOL if there is a substantial understatement of tax). So, if you have waited 3 years you may be ok. The period from 1-3 years if "iffy." If you have a contractual right or option with the seller of the replacement property to buy it in 2-3 years, there is a possibility the IRS could argue the step transaction doctrine applies because there is a binding commitment to sell the property to you.
Sorry I could not be more specific, but this is an unclear area of the law. You should consult with your tax advisor giving him or her all of the facts including your specific situation (including your prior year tax return information, as that can affect the result).
Regards,
Taxjunkie