Can I 1031 a "flip"?

Question

Hello BiggerPockets,

Quick Note: I did thorough research on this and keep getting contradicting advice.

I recently purchased a property with the intent of holding it as a long-term rental property. I cosmetically updated the entire house...new paint, floors, countertops, fixtures, and fence. My circumstances changed and I need to sell the property...I have owned the property for two months. I want to utilize the 1031 Exchange, but I am unsure if I qualify as I guess I "flipped" the property. I plan to buy my next property as a buy and hold.

Can I do a 1031 Exchange even though my original property might be considered a "flip"?

Can I buy two properties with my proceeds from the sell?

Does my original down payment and rehab costs have to go into an escrow account?

Is it only the capital gains that have to go into escrow account and I get my original down payment and rehab costs back tax free?

Any direction or advice will be much appreciated.

Thanks in advance

Dave Foster · Answer

@Kelby Schimming, I think you've got it.  Your answers to the other questions were spot on. If you want to defer all tax you must purchase at least as much as you sell and use all of the proceeds from your sale in the next purchase.

It's such a messy gray area of intent and how to demonstrate that intent. Did you put it up for rent.  Did you talk to property management firms?  What is your usual practice?  How will you hold the new properties?  Etc.  These are all questions that can help demonstrate your intent.

One should never do something wrong just because it might not be questioned.  But If you can say it to the mirror with a straight face then don't not do something that is right simply because it may be questioned.   An accident can happen.  It's when the same accident happens several times a year that it starts to look less.....accidental.

Eliott Elias · Answer

You can not 1031 a property you have owned for less than a year. The IRS will consider that a flip.

Kelby Schimming · Answer

Can I do a 1031 Exchange even though my original property might be considered a "flip"?

Answer: Although there is no direct rule stating this is unacceptable, according to case law "flips" are purchased with the intent to resell. If you cannot prove your intent, then the 1031 will be null.

Can I buy two properties with my proceeds from the sell?

Answer: Yes

Does my original down payment and rehab costs have to go into an escrow account?

Answer: No, but if not, it is considered "boot" and can affect tax liability.

Is it only the capital gains that have to go into escrow account and I get my original down payment and rehab costs back tax free?Answer: No, but if not, it is considered "boot" and can affect tax liability.Pretty sure these answers are correct. The only one that concerns me is the question related to the "flip" as there is nothing that clearly states you cannot do this. All answers I have found are just suggestions.

Kelby Schimming · Answer

Our intent was to rent the home, we posted it on Zillow, Hotpads, and put a "for rent" sign in the yard. We have 3 other rental properties and planned to hold the replacement property(s) as rentals. So with that, I believe our intent of renting is pretty clear, but I do know the IRS is not so understanding.

@Dave Foster Thank you for your feedback, specifically "don't not do something that is right simply because it may be questioned"

Ash Hegde · Answer

The answer is likely in the circumstances that made you sell rather than hold when you went into the project intending to hold. @Dave Foster has a lot of experience with 1031 exchanges and may be able to point you in the right direction.

Account Closed · Answer

KEY TAKEAWAYS - Hire the intermediary BEFORE you sell

• A 1031 exchange is a tax break. You can sell a property held for business or investment purposes and swap it for a new one that you purchase for the same purpose, allowing you to defer (not totally avoid) capital gains tax on the sale.
• 
• Proceeds from the sale must be held in escrow by a third party, then used to buy the new property; you cannot receive them, even temporarily.
• 
• The properties being exchanged must be considered like-kind in the eyes of the IRS for capital gains taxes to be deferred.
• 
• If used correctly, there is no limit on how frequently you can do 1031 exchanges.
• 
• The rules can apply to a former principal residence under very specific conditions.

45-Day Rule

The first relates to the designation of a replacement property. Once the sale of your property occurs, the intermediary will receive the cash. You can’t receive the cash or it will spoil the 1031 treatment. Also, within 45 days of the sale of your property, you must designate the replacement property in writing to the intermediary, specifying the property that you want to acquire.

The IRS says you can designate three properties as long as you eventually close on one of them. You can even designate more than three if they fall within certain valuation tests.

180-Day Rule

The second timing rule in a delayed exchange relates to closing. You must close on the new property within 180 days of the sale of the old property.

This is only for people who are organized and can focus on finding the appropriate replacement property during the right market conditions.

Kelby Schimming · Answer

Circumstances that are making me sell include the fact that we spent more on updating the home than we anticipated due to latent defects. Also, I reside in Qatar and my wife is in the states. She originally was going to stay in the states for a while, but she is now moving to Qatar this year. I guess the location of my wife is a moot point considering we would plan to buy something else within the 180 days.

Rick Pozos · Answer

The whole thing is predicated on intent. You say you intend to keep but 'have' to sell. BUT then you are going to buy something else. It does not sound like you HAVE TO sell after all.

I dont know your situation. I can tell you that the IRS are not the nicest people in the world. If they think you are not completely truthful, you will get fines, penalties, etc.

Can I 1031 a "flip"?

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