1031 Exchange - Flip House to Rental Property

Investor · Lehigh Acres, FL · Member since 2016 · 51 posts · 14 votes

I know this may be a silly question for the experienced REI and CPA's; but is it possible to roll a 1031 exchange from a flip house to a rental property. I know that the investments from the 1031 exchange has to be of similar category. They both are considered as real estate investments; although the are completely different. Please don't be too harsh on my newbie REI brain. I look forward to your helpful feedback.

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Jon Klaus

Developer · Garland, TX · Member since 2008 · 8k+ posts · 4k+ votes

10y

Can you make your flip into a rental? Later, after you've established intent to hold, you could 1031X. The key is showing intent and the more time you hold shows that (changed) intent. You might also hold in a different entity than you use for flipping.

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John Thedford
Real Estate Broker · Naples, FL · Member since 2013 · 9k+ posts · 6k+ votes
10y
No. Flips are considered inventory and not investment properties. Investments are "held" for investment purposes and generally must show on your tax returns for 2 years.
@Dave Foster is a 1031 expert and may wish to chime in.
BTW---they don't have to be similar. You can 1031 from a rental house to vacant land. You can 1031 vacant land to oil and gas rights. There are lots of possibilities as long as they are held for investment.
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Jon Klaus
Developer · Garland, TX · Member since 2008 · 8k+ posts · 4k+ votes
10y
Can you make your flip into a rental? Later, after you've established intent to hold, you could 1031X. The key is showing intent and the more time you hold shows that (changed) intent. You might also hold in a different entity than you use for flipping.
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Sean Pincus
Developer · Philadelphia, PA · Member since 2013 · 87 posts · 62 votes
10y
The tax code is a bit vague when in comes to this. IRS looks for INTENT when defining real estate inventory (flip house) or real estate investment (rental). If you bought the property with the intention of holding it but for some reason flipped it to sell, it could be considered a like exchange into a rental property because the intention was to hold it for rental at the onset. I would consult with a tax accountant.
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Jon Klaus
Developer · Garland, TX · Member since 2008 · 8k+ posts · 4k+ votes
10y
Paging Bill Exeter
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Robert Hetsler
Qualified Intermediary for 1031 Exchange" · Jacksonville, FL · Member since 2015 · 239 posts · 84 votes
10y
@John Thedford is correct on two items, one is that @Dave Foster is the local 1031 expert and he has earned that respect as I have had the pleasure of meeting him in person with our wives and he is simply a basket full of knowledge.
Having said that, the second thing that @John Thedford is correct on is the interpretation of like kind exchange, it is really very broad when deal with real property. It is actually easier to identify what does not qualify and that is really your primary residence. The short version of the rule is that selling investment property with the intent to buyer other investment property and hold for the foreseeable future. The IRS does not provide specific holding periods except when direct family is involved in the transactions and then it is sets forth a 2 year requirement so the conservative tax professionals will state two years is the holding period but I want to be clear that is not set in stone.
At the end of he day, you need to be able to state with confidence that the house you are liquidating to purchase investment property (lets define it as property purchased or held with the intent to hold for the foreseeable future) was investment property using my definition. That is my take on it. It also becomes a business/probability decision as well because the reality is that I have been doing these for right around 14 years and have handled several a month that have exceeded 20 plus million and never once has a client be selected for an audit. Let me be clear, that is nothing I have any control over and I seriously doubt the IRS is scared of me in anyway but I am stating it is in such a way that when issues tend to blur the lines a little, that has to be a consideration. You need to determine the negative and positive outcomes and weigh the positive and negatives against each other to make that decision. Remember, Tax Avoidance is legal and Tax Evasion is not Legal!
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Jim Carney
Professional · Houston, TX · Member since 2016 · 24 posts · 4 votes
10y
I agree with Robert Hester. Most investors try to make a 1031 exchange too difficult. Most are not. I've been doing them as an exchanger for 10 years and hayet to see an audit. There are very simple rules and intent trumps most.
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Bill ExeterBusiness Member
1031 Exchange Qualified Intermediary · San Diego, CA · Member since 2008 · 1k+ posts · 1k+ votes
10y
Hi @Willie Webb,
@Robert Hetsler is right on the money. There are really two issues being addressed here. The first is Qualified Use Property and the second is Like-Kind Property.
Qualified Use Property
Qualified Use Property is really the issue here. Qualified Use means that your relinquished property or properties and your replacement property or properties must be held for rental, investment or business use in order to qualify for 1031 Exchange treatment. The critical issue is your intent.
Property that is acquired with the intent to buy, rehab and then sell (flip) is actually held for sale as inventory in a real estate business and is not held for rental, investment or business use and will generally not qualify for 1031 Exchange treatment.
It would qualify if you bought, rehabbed and then held as rental property (instead of holding for sale), or if you could prove that you actually did have the intent to hold for investment but you had to sell early due to an economic or business reason. It all boils down to what you can demonstrate under audit.
Like-Kind Property
This one is easy. People make it way to difficult. It simply means that if you are selling real estate (as defined under state laws) then you must also buy real estate. The following list gives you an idea of how broad the definition of real estate really is under most state laws.
Like-Kind Real Property
The following list of real property asset classes represents interests in real property that usually qualify as like-kind property for 1031 Like-Kind Exchange purposes:
- Single Family Residential Property
- Multi-Family Property (Apartments)
- Commercial Office Properties
- Retail Shopping Properties
- Industrial Warehouse Properties
- Triple Net Lease (Net Lease or NNN) Investment Properties
- Agricultural (Farm) Properties
- Vacant Undeveloped Land
- Oil & Gas Interests
- Mineral Rights
- Water Rights
- Air Rights
- Easements in perpetuity
- Leases with a remaining life, including options, of 30 years or more
- Tenant-In-Common "TIC" Investment Property Interests
- Delaware Statutory Trusts "DSTs" Investment Property Interests
- Vacation rental properties (income producing)
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Willie Webb
OP
Investor · Lehigh Acres, FL · Member since 2016 · 51 posts · 14 votes
10y
@Bill Exeter, Thank you so much for your input. Very helpful!
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Dave FosterBusiness Member
Qualified Intermediary for 1031 Exchanges · St. Petersburg, FL · Member since 2013 · 9k+ posts · 9k+ votes
10y
@Willie Webb, The only other thing I would add to the discussion is to emphasize that your intent is what it is when you purchase the property. And you will demonstrate your intent one way or another. But your intent can change. Did you put it up for sale immediately? Or did you offer it for rent? What did you tell your accountant, realtor, etc? Your actions establish your intent. Most investors who use 1031s always buy with the intent to hold for productive use. Every once in a while something happens to change that intent. Those kinds of accidents happen - but they probably don't happen several times a year. Use the mirror as your test.
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Willie Webb
OP
Investor · Lehigh Acres, FL · Member since 2016 · 51 posts · 14 votes
10y
Good points @Dave Foster. My original intent was to flip, but it turned out to be a disaster, so I was planning on just refinancing, pulling out $40k from the equity,and then just use that money to pay the deposit on the next property. So Inguess you could say that I wanted to know if I needed to do an exchange on the equity cash out money.
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Wayne Brooks
Real Estate Professional · West Palm Beach, FL · Member since 2012 · 23k+ posts · 13k+ votes
10y
No, 1031's involve the Sale of the property....cash out refinancing is simply borrowing more money on the property.
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Dave FosterBusiness Member
Qualified Intermediary for 1031 Exchanges · St. Petersburg, FL · Member since 2013 · 9k+ posts · 9k+ votes
10y
@Willie Webb, This is one of the greatest opportunities within the 1031 business model. You get the benefits of buy and hold with appreciation, cash flow and tax deferred status. But with the use of strategic refinance you can also access capital to use in more acquisitions to either flip or buy and hold
@Wayne Brooks hit it on the head. The refi does not create a taxable event. So cash out to buy a flip or cash out to invest some other way. Shrink and grow your leverage but when it's time to sell a hold property use your 1031 to preserve that tax deferred status and use the govt's money for your own investing.
@John Thedford does a lot of work in the Lehigh Acres area. He may have some tips for you on that piece. Either way though you may find you're actually in a better situation this way.
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