1031 Exchange

Real estate agents who market to Baby Boomers are finding out the number one question asked by clients they work with in a §1031 Tax Deferred Exchange is: "How long must I hold the replacement property in an exchange before I convert it to my personal residence?"

The answer is: Qualifying property under §1031 must be held by the taxpayer for productive use in a trade or business or for investment. I.R.C. §1031 (a) (1). The determination of whether property is held for productive use in a trade or business or for investment is made as of the time of the exchange. If the "intent" of the taxpayer is to convert the replacement property to their personal residence, the tax is due and payable upon conversion.

The holding purpose may change while the taxpayer owns the property. Rev. Rul. 57-244, 1957 - 1 C.B. 247. For example, property held as a principal residence that later becomes rental property may qualify as investment property. Property being held as an investment may become the taxpayers personal residence. Remember, that it is what the taxpayer's intent was at the time of the exchange.

If a taxpayer completed a §1031 exchange and their replacement property was a single family rental, would the exchange survive an audit if their principal residence was destroyed in a fire and they were forced to convert the replacement property to their personal residence, all in the same tax year? Not sure, but it could. Again it is based on intent. The taxpayer did not intend to have their house burn down, nor move into the replacement property, but each auditor will most probably have their own interpretation. They will look at many factors, including, but not limited to; how long the original investment property was held, whether the taxpayer intends to rebuild what was their principle residence and if the intent for the replacement property is to have it once again become an investment property.

The length of time that a taxpayer holds the property prior to or following the exchange is an important factor. The longer the taxpayer holds the property before or after the exchange , the more likely it is that the property was held by the taxpayer for productive use in a trade or business or for investment. Unfortunately, the Service has not issued a clear rule in this area. Griffin v. Commr, 49 T.C. 253 (1967).

The more evidence showing the property is investment property the better. There is not a requirement that the property actually be used in a trade or business or for investment. As long as the taxpayer intends to hold the property for use in a trade or business or for investment at the time of the exchange, then the holding purpose requirement is satisfied. Wagensen v. Commr, 74 T.C. 653 (1980).

It can be somewhat nebulous. Keep in mind intent is key. Along with intent is length of time the investment property is held and having good documentation as to the property's intended use as a trade or business or for investment.

Remember, as a real estate agent you should not give advice on legal issues or tax matters. Taxpayers should always seek advice on any real estate transaction from a qualified attorney or accountant.

The OREXCO (Old Republic Exchange Facilitator Company) has completed over 21,000 §1031 tax deferred exchanges for real estate investors during the past eight years. Old Republic Exchange Facilitator Company is in the business of providing Peace of Mind. Information provided by OREXCO (Old Republic Title Exchange Facilitator).