Property Held for Sale or Investment - What's the Difference In a 1031 Exchange?

One of the key requirements for a real estate exchange to qualify under section 1031 for tax-deferral is that the property involved was held for either investment purposes or for productive use in trade or business. In many cases, this is a fairly straightforward proposition to prove.

However, in other exchanges, questions may arise as to whether this strict requirement has been met. For example, if you are an investor who flips properties or otherwise regularly buys and sells real estate, the IRS will scrutinize your #1031 exchange differently than the occasional real estate investor. That doesn’t mean that a broker cannot participate in exchanges, only that he or she must be careful to segregate that activity from day-to-day broker operations.

This doesn’t mean your exchanges won’t qualify, but knowing the factors the IRS scrutinizes will help you avoid unnecessary denials when it comes time to file your tax return.

The biggest thing the IRS will look to is your intent. Subjective? Absolutely. But while it is a somewhat amorphous and intangible thing to determine, the IRS does have some criteria that guides them to their final decision.

Although non-exhaustive (and keep in mind that every exchange is unique), the following general factors will help the IRS determine intent:

• The nature and purpose of the property acquisition
• The duration of ownership
• The extent and nature of the investor’s efforts to sell the property
• The number of sales executed by the investor
• The use of a business office for the property sale(s)
• How much control the investor exercises over the actual seller of the property (if the parties are different)
• The amount of time the investor regularly devotes to sales
• The ordinary course of business of the investor

If a 1031 exchange is in your future, visit our website to learn more about these powerful tax deferral tools and our qualified intermediary and replacement property locator services.