A 1031 exchange enables a taxpayer subject to US federal capital gains to defer the tax when selling and replacing real property held in the productive use of a business or for investment. Held is the key word, implying the property must be held for a period of time to qualify for a 1031 exchange. In the Internal Revenue Code Section 1031, a 1031 exchange holding period is not defined, though the IRS recognizes that two years is sufficient. In every 1031 exchange, facts, such as time the property is held, support the intent to hold the property to qualify for a 1031 exchange.
Vacation Property
In Revenue Procedure 2008-16, the IRS provides a safe harbor that if the taxpayer meets the time requirements, the IRS will not challenge whether the vacation home qualifies as property held for productive use in a business or for investment under section 1031. The vacation property must be held for two years and in each of those two years, the property must be rented out at fair market rent for 14 overnights. Given the replacement property is a vacation property, then it must be held for two years and rented out at 14 overnights at fair market rent for each year. Personal use must be limited to no more than 14 overnights per year. Overnights spent while maintaining the property do not count towards the 14 overnights.
Converting 1031 Rental to Primary Residence
When converting a rental or vacation property acquired in a 1031 exchange to a primary residence, the safe harbor applies, suggesting a two year hold as a rental prior to converting to a primary residence. To qualify for the Section 121 $250,000/$500,000 per taxpayer exclusion when selling the primary residence, the property must be held a total of five years, with at least two of those years as a primary residence. A primary residence is not an eligible replacement property when selling real property held for investment or in a business and initiating a 1031 exchange.
Hold Times of Less than Two Years
Intent while holding an investment property or in the productive use of a business can change due to work, health, family circumstances or unforeseen circumstances; consequently, the property can be exchanged in less than two years. The Revenue Procedure 2008-16 is a bright line test, but is optional unless the taxpayer wants the assurance the IRS will not challenge the 1031 exchange in an audit. Should the property be exchanged in less than one year, ordinary income taxes are triggered on the gain unless a 1031 exchange is initiated. If the property is sold after one year and a day, then long term capital gain rates apply which range for real property between 0 and 20 percent.
Flipping properties where the intent is for profit rather than for investment tends to not be eligible for a 1031 exchange, especially if the taxpayer flips multiple properties. The property must have facts that support the proper intent of holding for investment or in the productive use of a business. Itemizing the property on Schedule E and having the property managed by a property rental company with rental revenues, expenses and depreciation are good supporting facts.
The 1031 exchange holding period is exchange specific. Given good facts support the property, the hold period can range from less than a year to a conservative time frame of two years. Should you have questions regarding the sale of real or personal property, click here for a response from our team.
We Can Help
Atlas 1031 Exchange has been accommodating tax-deferred exchanges of all kinds for more than 17 years. We are fluent in the rules and regulations of IRC Section 1031 and able to help you navigate your exchange.
Contact us today to discuss any questions you may have. Call our office at 1-800-227-1031, email us at info@atlas1031.com, or submit your question through the online form at the top of this page.
