I had a question that was a bit above my current knowledge level, wanted to get some opinions here (thank you in advance). 2 months ago, my wife and I purchased an investment home that sits on a double lot. My agent suggested that our purchase price approximated the value of the home alone, which the comps seem to support, and the strategy has been to do some minor remodels to the home (finish basement by adding a 3rd bedroom, modest remodel of upstairs bathroom), then sell the home, and either sell the raw land separately, or build a house on the raw land and sell that - either way we will be doing a lot line-adjustment so that the house sits on a single lot. I'm confident that the pieces are more valuable than the whole here.
What I am primarily concerned about is the tax consequences. Specifically, how does the tax basis split between land & home upon the sale? Do i need to wait 12 months to sell either piece of property in order to avoid short-term capital gains tax? And what are my options on a 1031 exchange - my wife and I currently own 8 core workhouse single family rentals, so the thought would be to use the proceeds from this opportunity to reinvest into more core workhorse properties.
Thank you for your time
Building a house and selling assuredly won't qualify for a 1031. Simply subdividing the lot reselling probably eliminates the 1031 also, as it's more of a development/not held for long term investment looking situation. Others will have better determinations.
I also should have clarified that i am willing to put a renter in the house for a period of 12-24 months, if necessary. Thanks
Qualified Use Property
The most important point is that your properties or assets must be held for rental, investment or business use. Properties that are not held for investment or used in your trade or business (i.e. they are held for sale such as rehab/fix/flips) will not qualify for 1031 Exchange treatment.
Intent to Hold
You will notice that many investors and their advisors get hung up on the length of time that you have (or have not) held title to your property when trying to decide whether it would be considered qualified use property and therefore qualify for 1031 Exchange treatment. The amount of time is not the real issue here.
Your intent to hold your properties for rental or investment purposes is what really matters. You must be able to prove that you had the intent to hold your relinquished properties and your replacement properties for rental, investment or use in your trade or business should you be selected for an audit.
One of the best ways to demonstrate your intent to hold is to do just that — hold your properties sufficiently long enough so that you can easily prove you had the intent to hold for investment. So, the length of time helps to prove that you had the intent to hold, but it is not the only relevant factor. This is why many advisors and experts recommend a holding period of 12 months, 12 months and one day, or even 18 or 24 months.
Properties Held For Investment
Properties held for investment purposes can be any property or asset that you acquire and hold for income production (rental or leasing activities) or for growth in value (capital appreciation). Properties held for investment do not need to produce income or cash flow. They merely have to be held for investment in order to qualify for 1031 exchange treatment.
Properties Held for Sale (Inventory)
Properties or assets acquired and held for sale do not qualify as held for investment or used in a trade or business and will typically not qualify for 1031 exchange treatment. The acquisition of property for the purposes of fixing it up and then selling it, or what many refer to as rehabbing or flipping property, is a perfect example of property being held for sale and not held for investment. Acquiring a multi-family property and converting into condos and then selling individually is also a good example of property held for sale and not for investment.
Proving intent can be difficult as investors don't think about how they will prove their intent why they are putting together a transaction. Correspondence, emails, notes to the file, contracts, etc., are all vehicles that can be used to help document your intent to hold vs. held for sale.
Well said @Bill Exeter That is as good an explanation of qualified use as I have ever seen. In light of the recent Allen vs US decision where Allen's exchange was disallowed after owning his property for 12 years but never adequately demonstrating his intent to hold for investment your comments about how to demonstrate intent are particularly relevant and spot on.
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