When it comes to 1031 exchanges, there are really two essential litmus tests. The properties involved in the exchange need to be held for investment or business purposes, and you have to exchange for like-kind property.
The two areas we often see properties not qualifying for 1031 exchange. If you own a lake cabin you may have a property that’s used for your own personal edification. That property isn’t an investment or business property. Even though you may want it to go up in value, your personal use of the property trumps the purported investment intent. There have been many cases in which people have fought with the IRS about their appreciated personal property. The IRS has been making a point of winning those cases.
In the area of VRBO and AirBnB properties, the IRS has granted a pretty broad safe harbor for properties used primarily for rental programs. In that safe harbor, the IRS will look at the first two 12-month periods after you buy the property to decide if you have used the property primarily for investment or business purposes. So they’re going to test those periods to see that a) you’ve rented it at least 14 days a year, and b) you haven’t used it more than 14 days a year or more than 10% of the time the property has been rented out. So on your use side you could use it for 14 days. Or let’s say the property was rented out for 300 days. You could use It for 29 days personally because that would be under the 10% threshold.
It’s always a good idea to be very safe with these types of properties. Keep the property rented out as much as possible for the first two years.
The other property that doesn’t qualify for 1031 is property that’s been held primarily for resale. If you buy an apartment building and you convert it to condos and you sell each of those individual units to the public, then you’re a dealer. That real estate is your product, your stock in trade. You can’t do a 1031 exchange on your dealer property – property that you intend to hold for resale. The same goes for land developers.
In order to get around this, you can change the way you do business. Rather than buy a property and do a quick flip, you could instead buy the property and rent it out for a year or more. After that time, then you can do the improvements and sell the property in a 1031 exchange.
Start Your 1031 Exchange: If you have questions about 1031 exchanges, feel free to call me at 612-643-1031.
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