A 1031 exchange is utilized by taxpayers who are selling real and personal property held in a trade, business or for investment. The approved Internal Revenue Service strategy allows the taxpayer to defer or postpone payment of the federal and state capital gain and depreciation recapture tax. The tax does not go away, but rather is due when the replacement property sells and the taxpayer cashes out. The taxpayer can initiate as many 1031 exchanges as makes sense, but eventually, the tax is due.
Qualified Intent
The Internal Revenue Code Section 1031 states “no gain or loss shall be recognized on the exchange of property held for productive use in a trade or business, or for investment, if such property is exchanged solely for property of like kind which is to be held for productive use in trade or business or for investment.” Qualified intent means the property is held for use in a trade, business or for investment. Property acquired primarily for sale, such as stock in trade, inventory or dealer property, does not satisfy the qualified use requirement. A primary residence is not excluded, but rather it does not meet the qualified intent given the primary purpose is for personal use. A primary residence can always be converted to an investment property in which case it qualifies for recognition treatment under 1031 code.
Good Supporting Facts for Realtor and Developer
Realtors and contractors may make their living by either buying, selling or making improvements to real property they own. Should this constitute inventory, then the property is not eligible for 1031 treatment. How the realtor and developer account for the property’s income and expenses is one set of facts that supports an investor status. Realtors and developers, who in their normal course of business sell real estate, can own investment properties under another titleholder or entity and maintain a separate set of books. Making improvements to land begins to take on dealer status when roads and utilities are installed. Homes can be built for resale as a dealer while other houses may be held in a rental pool qualifying for non-recognition under Section 1031. The Regulations do not define “held for investment” though they do state “unproductive real estate held by a non-dealer for future use or appreciation is held for investment.”
Nine questions provide the criteria used by the courts to determine whether the taxpayer fact pattern represents a dealer or investor.
- The purpose for which the property was initially acquired
- The purpose for which the property was subsequently held
- The extent to which improvements, if any, were made to the property by the taxpayer
- The frequency, number and continuity of sales by the taxpayer
- The extent and nature of the transactions involved
- The ordinary business of the taxpayer
- The extent of advertising, promotion or other active efforts used in soliciting buyers for the sale of the property
- The listing of the property with brokers
- The purpose for which the property was held at the time of sale
There is no one determining factor; however, the court looks to the frequency and substantiality of the transactions.
Each exchange has a qualified intent when the property is initially acquired and a set of facts supporting it. The intent and factor pattern help to determine ultimately whether the taxpayer is either a dealer or investor subject to ordinary income or capital gains tax respectively.
To learn “Ten Reasons Why a 1031 Exchange Makes Sense,” click here.
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.
