Can the IRS Read Minds?

They try.

One of the key requirements of a valid 1031 exchange is that the relinquished and replacement properties were “held for business or investment” purposes. Unfortunately, the IRS Code does not offer any concrete rules that spell out what this general phrase means. Instead, the tax man will look to circumstantial evidence to determine whether investor’s intent related to the property meets strict IRS requirements.

So how can the IRS determine what is in the mind of the investor? Tarot cards and crystal balls are not involved, although some say the IRS approach is close. Instead, the IRS looks to actions and deeds surrounding the exchange to discern intent. And, to add insult to injury, the IRS puts the burden of proof on the investor.

Some of the factors an investor can use to substantiate intent include:

• A long period of ownership
• A use consistent with investment or business operations
• Tax reporting history that is consistent with investment or business use

Likewise, there are certain factors that tend to negate the “held for investment” intent, including:

• Sale of the property for profit shortly after acquisition
• Using the property primarily for non-investment purposes

Since determination of intent is purely subjective, it is important for an investor to be able to clearly identify tangible evidence of his or her investment intent when it comes to defending a 1031 exchange.

To learn more about 1031 exchanges or our qualified intermediary and replacement property locator services, please visit our website.