Real Estate Investment Articles

One of the most common questions I hear deals with the holding period requirements for 1031 exchanges. First the background: a 1031 exchange rolls the gain from the sale of your old investment property to the purchase of your new investment property. To be "like kind," both the old and new properties have to be investment property. Property that is held for resale (i.e., "fix and flip" property) is specifically excluded from the benefits of this code section.

The question of "held for investment" versus "held for resale," often comes down to your intent at the time you bought the property, and how long both the old property and new property are held by you. The court cases are all over the map on this one, but the general rule is that you should hold the old property for a least a year before you sell it, and you hold the new property for at least a year after you buy it. We tell our clients to hold each property for at least a year and a day to be safest.

There are two reasons for the one year rule: first, it satisfies the majority of the court cases which tend to look to the intent of the taxpayer, and second the holding period for taxable long term capital gains is one year.

The most misunderstood part of the holding period rule deals with a concept that the IRS and tax professionals call "tacking". In a normal, taxable transaction, where the basis of the property you receive is determined by the basis of the property you gave up, the holding period of the property you receive begins at the moment you receive it, and the holding period of the old property is "tacked" on.

The IRS issued a couple of rulings in the mid 1970's that say that tacking does not apply in a 1031 exchange transaction. (1) The IRS is holding to these rulings and say that they are still good law. Thus, it is likely that if you tried to argue with the IRS that your holding period for a newly acquired 1031 exchange property "tacked" onto the holding period of the property you sold in the exchange, you would lose.

The same problem can apply in your dealings with the new property you exchanged into. For example, it's a common practice for exchangers to transfer their new property immediately into an LLC, partnership, or corporation to insulate them from personal liability. This can be a problem. The IRS may argue that the sale of real estate followed by a purchase of real estate and then a transfer to a corporation or partnership is a multiple step transaction, the essence of which is that you sold real estate and acquired a corporation or partnership interest which is not like kind for like kind.

The IRS could also argue that you "sold" the real estate to the corporation or partnership immediately after you acquired it, and therefore you acquired it for resale, not for investment because you didn't hold it for a year.

It's common to see transactions where the client's attorney has dissolved the corporation or partnership that held the property immediately before the sale of the old property. It's also common to have clients transfer the new property into a corporation or partnership immediately after the purchase of the new property. There may be good business and legal reasons for doing either, but you should be aware that both can have fatal exchange consequences. The safest course of action is to not transfer title to the property to anyone for at least a year and a day after it is acquired by you. Call us for more information tailored to your specific situation.