1031 Exchange on a flip

Real Estate Investor · Baltimore, MD · Member since 2008 · 619 posts · 75 votes

I have 2 properties that are getting ready to Settle in the next 30 days, I would like to do a 1031 Exchange either into another flip or into rentals. I have read conflicting info on this topic in regards to flips, can anyone provide more insight or direction? Thanks!

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Steve Babiak

Real Estate Investor · Audubon, PA · Member since 2009 · 13k+ posts · 8k+ votes

12y

Originally posted by @Anthony Dooley:

In the future, if you want to use 1031 exchanges, let your closing attorney know this when you are buying the property, don't just wait until you want to sell it. You must use an attorney when doing a 1031 exchange. They hold the money from the sale and will release it to buy another like property. There is a time limit. You cannot touch the money or else you have to pay the capital gains taxes.

I think there is some confusing info in that post.

You don't have to use an attorney to close a 1031 exchange - but you must use a Qualified Intermediary (QI) who may or may not be an attorney.

When I buy a property to hold as a rental, I have no idea whether it is going to be relinquished down the road via 1031 exchange, so why would I involve a QI at that point as that post suggested? Sure, when I buy a replacement property, i know it is part of a 1031 exchange so it goes through the QI, but otherwise buying a property does not involve a QI.

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Jean BolgerPro Member
Aurora, CO · Member since 2012 · 2k+ posts · 1k+ votes
12y
These are flips that you are selling? Flips are not eligible for 1031 exchange, sorry. The "conflicting info" that says they are is either bad info or just wishful thinking ;)
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Bill ExeterBusiness Member
1031 Exchange Qualified Intermediary · San Diego, CA · Member since 2008 · 1k+ posts · 1k+ votes
12y
Hi Terry,
Jean is correct. In order to qualify for 1031 Exchange treatment, properties being sold and the properties being acquired must be held for rental, investment or use in a trade or business. Properties acquired for rehab and then immediate sale, in other words flipping, do not qualify for 1031 Exchange treatment. The IRS views these properties as inventory held for sale in a real estate business and not real property held for rental or investment purposes.
Bill.
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Anthony Dooley
Investor · Columbus, GA · Member since 2014 · 2k+ posts · 1k+ votes
12y
In the future, if you want to use 1031 exchanges, let your closing attorney know this when you are buying the property, don't just wait until you want to sell it. You must use an attorney when doing a 1031 exchange. They hold the money from the sale and will release it to buy another like property. There is a time limit. You cannot touch the money or else you have to pay the capital gains taxes.
1 Reply
Steve Babiak
Real Estate Investor · Audubon, PA · Member since 2009 · 13k+ posts · 8k+ votes
12y
Originally posted by @Anthony Dooley:

In the future, if you want to use 1031 exchanges, let your closing attorney know this when you are buying the property, don't just wait until you want to sell it. You must use an attorney when doing a 1031 exchange. They hold the money from the sale and will release it to buy another like property. There is a time limit. You cannot touch the money or else you have to pay the capital gains taxes.
I think there is some confusing info in that post.
You don't have to use an attorney to close a 1031 exchange - but you must use a Qualified Intermediary (QI) who may or may not be an attorney.
When I buy a property to hold as a rental, I have no idea whether it is going to be relinquished down the road via 1031 exchange, so why would I involve a QI at that point as that post suggested? Sure, when I buy a replacement property, i know it is part of a 1031 exchange so it goes through the QI, but otherwise buying a property does not involve a QI.
5 Reply
Bill ExeterBusiness Member
1031 Exchange Qualified Intermediary · San Diego, CA · Member since 2008 · 1k+ posts · 1k+ votes
12y
Originally posted by @Anthony Dooley:

In the future, if you want to use 1031 exchanges, let your closing attorney know this when you are buying the property, don't just wait until you want to sell it. You must use an attorney when doing a 1031 exchange. They hold the money from the sale and will release it to buy another like property. There is a time limit. You cannot touch the money or else you have to pay the capital gains taxes.
I thought I would jump in here to clarify the statement made above. You do not to use an attorney to structure a 1031 Exchange transaction. You must use a Qualified Intermediary in order to qualify for 1031 Exchange treatment.The majority of Qualified Intermediaries are not attorneys.
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David Krulac
Mechanicsburg, PA · Member since 2013 · 3k+ posts · 2k+ votes
12y
@Steve Babiak
is right on. You don't need an attorney to be a QI and you don't need if set up when you buy for long term buy and hold property.
Most anybody who you trust with large sums of your money can be a Qualified Intermediary. One famous real estate book author told me he uses his next door neighbor as his QI.
I've been doing 1031s for about 25 years, and they are hard to do as I talked about in the Bigger Pockets Podcast #82.
@Bill Exeter
I thought there was a provision that if your "intent" was to hold the property as an investment, but some circumstance changed that you could still do a 1031 even if the property was not a long term hold. Clearly fix & flip and wholesaling do NOT qualify as 1031a.
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Bill ExeterBusiness Member
1031 Exchange Qualified Intermediary · San Diego, CA · Member since 2008 · 1k+ posts · 1k+ votes
12y
@David Krulac
Hi David, you are correct. The Treasury Regulations clearly indicates that an investor must have the intent to hold the Relinquished Property and the Replacement Property for rental, investment or business use. It is possible that the investor's intent can change, but if the investor gets audited they will have to demonstrate that they did in fact have the intent to hold both properties for rental, investment or business use. If it appears that the investor did not have the intent to hold for rental, investment or business use, then their 1031 Exchange transaction would be disqualified. For example, an investor may have acquired their Replacement Property through a 1031 Exchange with the intent to hold the property for rental or investment purposes. The investor may then experience unanticipated financial or other hardships such as a loss of a job, medical emergencies, corporate relocations, etc., that may force the investor to move into the rental property instead. Investors 1031 Exchange transaction would likely still qualify because they did in fact have the intent to hold for rental or investment purposes, but had an unexpected a life changing event. T
Clearly, any properties held for sale, such as properties acquired for rehab and immediate sale, properties acquired for development and immediate sale, multi-family properties acquired for condo conversion projects and immediate sale, etc. will not qualify for 1031 Exchange treatment.
Bill.
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Mary B.
Real Estate Investor · Lansdowne, PA · Member since 2013 · 1k+ posts · 656 votes
12y
@Terry Royce Here is a bp blog link that you might want to read:
http://www.biggerpockets.com/renewsblog/2014/08/21...
Kudos,
Mary
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David Krulac
Mechanicsburg, PA · Member since 2013 · 3k+ posts · 2k+ votes
12y
@Bill Exeter
Thanks for your quick and detailed response.
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Brandon SturgillBusiness Member
Real Estate Broker · Columbus, OH · Member since 2013 · 3k+ posts · 1k+ votes
12y
@Steve Babiak @Bill Exeter @David Krulac Hey, guys. If you are still tuned into this post, what is the time frame for holding the property. I am looking to 1031 my primary residence next year and thought the property had to be owned for five years and occupied for two of those years. Is this incorrect?
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Eric Doud
Residential Real Estate Agent · Chesapeake, VA · Member since 2014 · 48 posts · 15 votes
12y
@Brandon Sturgill If it is your primary residence you don't need to do a 1031 exchange. You just need to own the house for two years to not have to pay any capital gains tax.
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Brandon SturgillBusiness Member
Real Estate Broker · Columbus, OH · Member since 2013 · 3k+ posts · 1k+ votes
12y
So, what about a non-occupied property...is there a "seasoning" period the investment has to be owned/held prior to executing a 1031?
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David Krulac
Mechanicsburg, PA · Member since 2013 · 3k+ posts · 2k+ votes
12y
@Brandon Sturgill
There is no prescribed holding period for the relinquished property of a 1031 exchange. But it must be an "Investment" property. And by definition a personal residence, a second home, a vacation home, a third home, etc are NOT investment properties. Also ALL dealer properties don't qualify, that would include flips, wholesale deals, builder properties etc.
If you bought a property today and 1031ed it tomorrow, the argument could be made that the property was NOT an investment property. If audited you would need to present reasonable arguments on why a property qualified as an investment and not dealer property, or property "held in trade" as inventory. Property held in trade/inventory does not qualify as a 1031. Many tax people say that you should own the property for a year or two before 1031ing it. But there is no spec in the code. If you are 1031ing in less than a year, you should have a reasonable story as to why this is an investment and not inventory.
One argument might be that you have a job transfer hundreds of miles away and your investment changed so that your properties could be closer to your new home. But if you already do long distance investment across the country, you pretty much can't use that argument.
Brandon, you can sell your personal residence every two years as long as you occupied the house for 2 of the last 5 years. There is no exchange, you don't have to buy a replacement property and it is NOT a1031 which is for investment property only.
@Eric Doud That's not entirely correct on a personal residence, if owned singly the capital gains tax free limit is $250,000 of gain. If married its $500,000. Its not unlimited, and you can do it every two years and there is no age limitation as in previous law on the subject.
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Steve Babiak
Real Estate Investor · Audubon, PA · Member since 2009 · 13k+ posts · 8k+ votes
12y
@Brandon Sturgill when you look to sell your residence, you are looking at the Section 121 exclusion. Read up on that at the IRS website.
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Eric Doud
Residential Real Estate Agent · Chesapeake, VA · Member since 2014 · 48 posts · 15 votes
12y
@David Krulac your right but I thought the profits were already talked about in this post. 250000 for single and 500000 for married. I was just giving a quick answer.
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Bill ExeterBusiness Member
1031 Exchange Qualified Intermediary · San Diego, CA · Member since 2008 · 1k+ posts · 1k+ votes
12y
Originally posted by @Brandon Sturgill:

@Steve Babiak @Bill Exeter @David Krulac Hey, guys. If you are still tuned into this post, what is the time frame for holding the property. I am looking to 1031 my primary residence next year and thought the property had to be owned for five years and occupied for two of those years. Is this incorrect?
Hi Brandon,
The sale of a primary residence does not qualify for 1031 Exchange treatment, but rather qualifies under Section 121.
In terms of a 1031 Exchange transaction for the sale of a rental, investment or business use property, there is no specific specified holding period. I realize that there are many opinions posted throughout the Internet that indicate an investor must hold the property for at least 12 months, or one year and one day, or 24 months ,etc., but the Treasury Regulations have absolutely no holding period required. The Treasury Regulations merely requires that an investor clearly have the intent to hold the relinquished property and the replacement property for rental, investment or business use purposes. An investor could have held the property for 10 years, but his or her 1031 Exchange transaction would still be disqualified if his or her intent were to hold the property for sale such as a rehab/flip versus held for investment purposes.
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Brandon SturgillBusiness Member
Real Estate Broker · Columbus, OH · Member since 2013 · 3k+ posts · 1k+ votes
12y
@Steve Babiak @Bill Exeter @David Krulac Thanks for the education, gentlemen.
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Terry Fox
Investor · Ellington, CT · Member since 2012 · 60 posts · 16 votes
11y
I am considering buying a single family foreclosure and the fixing the house up. If we then flipped it and sold it, we would have to pay income tax on the profit. So I am thinking it makes sense to rent the house out for one year and then sell it, as it would then qualify for a 1031 exchange (provided we put the proceeds from the sale into another property). Is this a common strategy that people use? Are there downsides?
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Dave FosterBusiness Member
Qualified Intermediary for 1031 Exchanges · St. Petersburg, FL · Member since 2013 · 9k+ posts · 9k+ votes
11y
@Terry Fox
When you go back over multi year string of this post you'll see some common threads.
1.Intent not hold time is key.
2.Demonstrating that intent is your biggest challenge and hold time can play into this.
3. By common definition a fix n flip is purchased primarily for resale and does not qualify for 1031 treatment.
I've long advocated the simple twist you are contemplating. Instead of fix n flip, do a fix- rent -1031, or a rent-fix-1031. Use the additional time to stack on appreciation and the cash flow to reduce the next expense of the fix up. Buy renting the property and establishing your intent to hold it for productive use you are adding an huge to your net return by enabling the 1031 possibility.
Good for you.
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Steve Buchanan
Rental Property Investor · Los Angeles, CA · Member since 2013 · 119 posts · 51 votes
11y
If you have a personal residence that you live in for 2 years and then move into a new house for 2 years while renting out the first house does this disqualify the first house from receiving the primary residence tax exemption if you sell it since it's no longer your primary residence?
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Bill ExeterBusiness Member
1031 Exchange Qualified Intermediary · San Diego, CA · Member since 2008 · 1k+ posts · 1k+ votes
11y
@Terry Fox
I would scroll up and read some of our prior posts that will help explain this, but your intent to hold for rental or investment purposes is the key element. If you get audited and it is clear that you intended to buy, rehab and sell (flip), you are actually holding for sale and not investment and will technically not qualify for tax-deferred exchange treatment. If you can demonstrate that your intent was to buy, rehab and then hold for rental, you will qualify for 1031 Exchange treatment.
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David Krulac
Mechanicsburg, PA · Member since 2013 · 3k+ posts · 2k+ votes
11y
@Steve Buchanan
No, if you live in your personal residence for 2 years, then move out, and rent it, and then sell BEFORE the 5 yrs expires, you still get the personal exemption of either $250,000 or $500,000 capital gains tax free.
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Steve Buchanan
Rental Property Investor · Los Angeles, CA · Member since 2013 · 119 posts · 51 votes
11y
@David Krulac
Now what if you live in your primary residence for 2 years, move out, rent it for the next 10 years and then want to sell? Since your 5 years has expired you are disqualified for the primary residence exemption but can you qualify for a 1031 exchange now? I know the answer lies in the intent you had when you initially purchased the property. Can you argue that your initial purchase of the house as a primary residence was also for investment purposes?
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Jesse T.
Herndon, VA · Member since 2014 · 1k+ posts · 324 votes
11y
Originally posted by @Steve Buchanan:

@David Krulac
Now what if you live in your primary residence for 2 years, move out, rent it for the next 10 years and then want to sell? Since your 5 years has expired you are disqualified for the primary residence exemption but can you qualify for a 1031 exchange now? I know the answer lies in the intent you had when you initially purchased the property. Can you argue that your initial purchase of the house as a primary residence was also for investment purposes?
What you did in that scenario was acquired the property for personal use and then converted it to a rental property. As a rental property it is eligible for a 1031. The relevant "acquisition" is the conversion to a rental property. One note on the basis is if your property was at a lower value at the time of conversion you have to use that vs. the purchase price(also for depreciation calculations).
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David Krulac
Mechanicsburg, PA · Member since 2013 · 3k+ posts · 2k+ votes
11y
@Steve Buchanan
That's right after 10 years of not living in the property you lose the personal exemption UNLESS you move back in for the next 2 years then sell.
Or if you don't move in you can do a 1031 exchange.
The 1031 is more difficult, has more rules, 45 day identification, settle in 180 days, etc. etc.
For the personal residence exemption you have to live there 2 years, and don't have to buy a replacement property, and don't have to be a certain age, and you can do it multiple times.
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