Personal Development

Unsolicited Offer You Can’t Refuse? How to Avoid a Big Tax Hit When Selling Unexpectedly

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It’s an investor’s dream scenario. You purchase a distressed property and start on the mountain of repairs and renovations. Then, someone else sees and wants—no, needs—your property.

Enamored by your real estate, they propose to pay you more than you paid. Before the sweat equity even begins to form on your brow, you receive an unsolicited offer at a handsome profit.

Profit without pain—what could be better? Well, profit without pain and no tax hit while unexpectedly moving on to the next investment property would be best case scenario.

Getting an Unsolicited Offer

This is exactly what happened to BiggerPockets member Jay. He is a rehab hold investor on a fast track to quitting his day job.

He purchased a rental property and was in the very initial stages of its rehab. Then, less than a month after closing, another investor spotted his smart play and offered him a handsome profit.

Despite his habit of buying and holding, at the time he received the offer, Jay had learned of a six-plex that would be the perfect addition to his portfolio. But he did not have the capital to hold and renovate the initial property and get the six-plex, as well.

Then came the unsolicited offer. Jay accepted the offer and began to work the numbers for the six-plex. He was very close, but the tax bill on the gain from the unexpected sale put the replacement purchase just out of reach.

If he could keep his taxes working for his own benefit using a 1031 exchange, it would be a game changer—but he didn’t think he had satisfied the hold period.

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Holding Period for a 1031 Exchange

The hold period is only one of the ways that the IRS differentiates between dealers (intent to sell) and investors (intent to hold). Investors qualify for 1031 exchanges and dealers do not. A longer period of ownership can be one indicator of an investor’s intent to hold.

It was three days before he was to close on the sale from the unsolicited offer. Jay threw out a Hail Mary appeal post on the BP forum.

Based on his question and our follow-up conversation, I was able to show him how he could use all his profit—even the taxes—toward the purchase of his replacement six-plex.

Even though he had held the property only a short time, he and his accountant determined that he was eligible to defer all tax. This is because the IRS can take many factors into consideration when determining the intent of the investor in a 1031 exchange.

Typically, an investment property is considered to be held for trade, business, or investment and eligible for 1031 tax deferral when you have owned it for 12 months or more. Longer is better than shorter.

Related: The Ultimate Guide to Real Estate Taxes & Deductions

Showing Intent is Key

The keyword that the entire 1031 exchange statute hinges on is “intent.”

Think about the farmer who goes to an auction and buys a piece of land. Three months later, he sells it for 10 times what he paid.

Is he a dealer or investor? His intent can be determined by looking at his history, his actions, and his communication.

  • He is a farmer with a history of holding property for productive use.
  • Did he plant a crop on the purchased land?
  • Or throw up a “for sale” sign?
  • Did he seek out the buyer?

His history of holding for productive use, his action in planting a crop, and his lack of a “for sale” sign demonstrate intent. And the unsolicited offer is the strongest piece of evidence.

Much like Zillow’s “make me move” appraisal pricing, it’s hard to argue about a deal too good to refuse. I’ve heard many times from grizzled old professionals, “I’ll never sell anything—unless it’s the right price.”

This brings me back to Jay. He had a history of rehabbing and renting property. But he found himself in the process of selling a piece of property that he had only owned briefly and had intended to use for other purposes.

The unsolicited offer was that much more attractive due to his interest in purchasing the six-plex (aka a replacement property) to rehab and rent. Fortunately, he had clearly stated his intent with the first property to his family, friends, realtor, and tax professional prior to receiving the unsolicited offer.

Just because he received an unsolicited offer did not change his original intent. It did not mean he intended to flip the property all along.

He established his intent with integrity and could look at himself in the mirror and say, “I truly meant to hold this property.”

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Preparing for a 1031 Exchange

Jay made his inquiry regarding a 1031 exchange just 72 hours before his closing. As soon as he decided to keep his taxes working for his own benefit instead of immediately forking them over to Uncle Sam, we jumped into action.

This is because a 1031 exchange must be in place prior to the sale of the investment property. And selling without the 1031 exchange would have made his distressed six-plex replacement property unattainable.

While 1031 exchanges have six requirements that must be adhered to, my team was able to walk Jay through the entire process. We coordinated with his closing team to prepare the necessary documentation. We handled all the background work while he focused on his sale and purchase.

He handily met all requirements and closed his sale and then his purchase.

Related: How to Minimize the Tax Bite When Selling Your Investment Property

Checking in on Jay

I checked in with Jay about six months after his exchange. He was just finishing up the renovation of his six-plex and had begun renting out units.

He was successfully able to leverage the unexpected windfall from his unsolicited offer and his own taxes into a bigger and better deal.

If you own real estate that you purchased with the intent to use for productive use in trade, business, or investment, you may qualify for a 1031 tax deferral, regardless of your holding period. The IRS created a safe harbor test in Rev. Proc – 2008-16.

However, it is important to understand that this safe harbor is not restrictive or definitive. Outside the safe harbor, no single method of documentation provides a fail-safe litmus test for 1031 exchanges. Yet, various case rulings support other measures.

Explore all options rather than harm your portfolio growth potential just because your circumstances are unique. And as always, seek counsel from a professional financial adviser familiar with your situation before making tax-related decisions.

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Want to learn how you could be saving more on your real estate taxes using loopholes, deductions, and more? Get the inside scoop from Amanda Han and Matthew MacFarland, real estate investors and CPAs, in Tax Strategies for the Savvy Real Estate Investor. Pick up your copy from the BiggerPockets bookstore today!

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Are you making the most of the tax benefits available to investors?

Let’s discuss in the comment section below. 

Dave Foster, real estate investor and qualified intermediary, has 20 years of experience working in all phases of real estate investing, from large scale development to single family homes and vacation rentals. This experience has given him a keen eye for opportunity and a clear vision for reducing the impact of taxes. A degreed accountant with a Master’s in management, Dave is Regional Director for Exchange Resource Group and has recently launched his own educational website, The 1031 Investor. Dave has built his reputation on being a driven, results-oriented 1031 Exchange Qualified Intermediary who works relentlessly to maximize value for the real estate investors he works with. He has taught numerous certified continuing educations courses on investment tax strategies. His particular focus on basic and advanced 1031 exchange topics has made him a popular guest speaker for local realtor associations, investment clubs, and podcasts. He teaches agents, investors, and advisors alike the ins and outs of 1031 exchanges and other tax and investment options.

    James Free Rental Property Investor from Fort Collins, CO
    Replied 4 months ago
    This is a very useful article. Thanks, Dave!
    Dave Foster Specialist from St. Petersburg, FL
    Replied 4 months ago
    Glad you enjoyed it!
    Scott Schultz Rental Property Investor from West Bend, WI
    Replied 4 months ago
    @Dave Foster, Could you do a followup if Jay ever gets Audited and see if this holds up, Im not nay saying just curious to see if there are examples of IRS audits where this was the scenario and how the story held up in the Audit. So much of the tax law is subjective and out for interpenetration, but just because its justified in one persons mind doesnt mean it justified by everyone. Interesting Read
    Dave Foster Specialist from St. Petersburg, FL
    Replied 4 months ago
    Great feedback Scott. And something every investor needs to think about. The facts of your individual situation are always going to provide the guiding parameters if audited when dealing with intent. So it is indeed very difficult to take individual situations and use them to create blanket precedents. But just like it’s foolish to do something wrong just because you can get away with it, it’s equally wrong to not do something appropriate for you just because it may be questioned.
    Steve Vaughan 10X Napper & Landlord from East Wenatchee, Washington
    Replied 4 months ago
    Awesome article, Dave Way to keep our silent partner at bay til another day. Until learning from you over the years I thought there was a minimum hold time before we can 1031. Intent is what matters. Perfect for buy and holders that can demonstrate a history of holding for productive use. Keep these great articles coming!
    Dave Foster Specialist from St. Petersburg, FL
    Replied 4 months ago
    Thanks for the great feedback, Steve!
    Tony Wooldridge Flipper from Walla Walla, WA
    Replied 4 months ago
    GR8 article Dave, thanks so much for sharing. I have heard about and read about the 1031, but its awesome to read a REAL WORLD application to how it benefited a fellow BP member. I will definitely have to become part of the 1031 CLUB one of these days. Obviously, I know whom to contact now to get that done. Thanks for the enlightening article!
    Dave Foster Specialist from St. Petersburg, FL
    Replied 4 months ago
    The 1031 CLUB always has room for new members!
    Scott Smith Attorney from Austin, TX
    Replied 4 months ago
    Great article, Dave! Nice to see you contributing quality content, keep up the good work.
    Dave Foster Specialist from St. Petersburg, FL
    Replied 4 months ago
    Thanks, Scott.
    Ashley Pimsner Rental Property Investor from Saint Charles, IL
    Replied 4 months ago
    Very informative article Dave. This may be a bit off topic but is it possible to make an like kind exchange with title showing husband and wife for a commercial property, and then create an LLC and have title changed for protection? Reason I am asking is that I sold a condo which was in my name and wife’s and then purchased a 6 unit. My commercial lender allowed me to finance loan using like kind title to preserve 1031 requirements, but I was just served first slip and fall lawsuit so I would like protection of LLC. I have heard around forums that it would be best to wait 2 years before changing title, but I was hoping you could give me further guidance.
    Cody L. Rental Property Investor from San Diego, Ca
    Replied 4 months ago
    Funny. I just had this ‘problem’. Bought a big (100+ unit) property for $x/door. 3 months later I was offered $y/door. I’m not really a seller but it ended up being a big diff so I took it. Then got hulk smashed in taxes. Still did well. But writing a monster check to IRS is still no fun. Normally I have enough costs to offset all my gains. Not this time.
    Dave Foster Specialist from St. Petersburg, FL
    Replied 4 months ago
    That’s exactly why I chose this topic. I found 1031 exchanges 20 years ago AFTER I got hulk smashed the first time. I remember the pain of that monster check . . .
    John Murray from Portland, Oregon
    Replied 4 months ago
    This why it is so important to have a big picture game plan. If and individual is so enamored by a $50K short term profit and payout income tax, SS and Medicare one should analyze their big picture game plan. RI is not a short term profit generator but a huge undertaking combined with multiple income streams and many avenues of profit. RI, passive and portfolio income is the key to wealth building.
    James H. Investor from Florida
    Replied 4 months ago
    Great article Dave! We are fortunate to have a forum/blog like yours with useful content that allows for transparent Q&A discussions. There is definitely a gray area when selling a property quickly then using a 1031 exchange, but when the intent and appropriateness can be proven and is justified why not take use the tools afforded to us? Thanks for keeping us newbie buy and hold investors on the up n up. -J
    Stacee Evans Investor from Canoga Park, CA
    Replied 3 months ago
    This is an interesting article. I’ve had rentals for years and have done a 1031 exchange in the past. I’m in the middle of my first flip and it occurred to me that my expenses for selling combined with the taxes I’ll pay are really going to eat into my profit. I’m now rethinking my plan and may rent it out for a little while then sell it to purchase something bigger using a 1031 exchange. Either way, it sounds like avoiding the extra taxes and maybe even renting it out for a little while instead of just flipping it may be a better idea. It sounds like if I just put it on the market right away, it won’t qualify for a 1031 exchange, so maybe someone will come to me and want to purchase it like what happened with Jay.