1031 for a Rehab?

11 Replies

I'm new to the investment world and trying to learn everything I can from all you smart and educated people here (big thanks to @jonholdman)!

I went to a financial / flipping seminar and listened to this strategy of how to make $ with little to no taxes....

You rehab a house; file a 1031 exchange with IRS before closing, and purchase another house to rehab within 45 days.... after this rehab (or maybe a 3rd if needed) you then put those earnings into a buy & hold property by way of a trust (grandchildren, child, etc). This trust can't be taxed for 5 Generations. Now you are earning the monthly rental income from this property, and have avoided large taxes.

Has anyone done this, or know if it's legit?

http://en.wikipedia.org/wiki/Internal_Revenue_Code_section_1031


Flips are considered "inventory" and not "investments" therefore, they are not eligible for a 1031 exchange, however, there are exceptions. Intent plays a huge role and owning a property for at least one year is also a milestone likely needed.

Something I just learned this year and that is all funds you placed into the purchase and rehab would have to be moved into the 1031 or else, anything pulled would be considered boot and taxable.

@Becky Nichols Jon and Will are correct. Properties involved in a 1031 Exchange must be held for investment (as opposed to held for sale like flips are).

The Dynasty Trust is the only generation skipping trust I know of and it set title to grandchildren bypassing the child of the grantor. Income from the property may be used by the child. I've never heard of skipping five generations, that doesn't even make sense to me that Uncle Sam would wait 100 or even 200 years to collect transfer or tax gains. Steven might laugh. :)

How long would it take to be considered an investment, a year?

There are no strict guidelines about length of ownership term, and there's a lot of debate on the forums about time vs. intent.

Most people I think would say, one year is the safe way to go.

@Becky Nichols

Holding period is irrelevant if the intent is to hold the property for resale. There is a Tax Court case where a speculator purchased vacant land, then immediately put it on the market to sell. When the listing agreement expired, the listing was extended, again, and again, and...

Finally, after ten years, a buyer came forward and purchased the property. The owner's long term capital gains tax treatment was denied and the sale was deemed to be sale of dealer realty (a flip) even though the holding period was more than ten years. The Tax Court upheld the IRS argument that the intent was always to flip the property since it remained continuously for sale during the entire holding period.

Originally posted by @Becky Nichols :
How long would it take to be considered an investment, a year?

Hi Becky,

It is the intent that counts - not the holding period. The holding period is just one of the factors the IRS would look at to determine what your intent was. If your intent is to acquire, rehab and then sell, it does not matter if you hold it for 3 months, 3 years or 3 decades, because your intent was to hold for sale and not hold for investment.

Having said that, your intent can certainly change, so if you acquire with the intent to flip, and then decide to convert it to rental property and hold for investment, you would qualify for 1031 Exchange treatment. You have to be careful and document your intent.

Originally posted by @Becky Nichols :

I'm new to the investment world and trying to learn everything I can from all you smart and educated people here (big thanks to @jonholdman)!

I went to a financial / flipping seminar and listened to this strategy of how to make $ with little to no taxes....

You rehab a house; file a 1031 exchange with IRS before closing, and purchase another house to rehab within 45 days.... after this rehab (or maybe a 3rd if needed) you then put those earnings into a buy & hold property by way of a trust (grandchildren, child, etc). This trust can't be taxed for 5 Generations. Now you are earning the monthly rental income from this property, and have avoided large taxes.

Has anyone done this, or know if it's legit?

http://en.wikipedia.org/wiki/Internal_Revenue_Code_section_1031


 Flipped properties are not allowed in a 1031 exchange. (unless of course, you have held the property for at least a year before flipping it).

In order to qualify for a 1031 exchange, you need to HOLD the property.  I'm not sure that the IRS has put an exact timeline on how long you need to hold it for, but the intent is that you would have income through appreciation or rental income, not by instant sale.

Also, in a 1031 exchange, the entity that sells the first property needs to be the SAME entity that buys the next property.  So, working your trust into the line of ownership doesn't really work either.

You may want to speak with your accountant before venturing forward with something like this.

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