Can you 1031 a flip?

8 Replies

Hey guys, I'm getting ready to close (selling) my first flip in Dec. I'd like to roll the profits into the next one, but I've read that you can't roll flip profits to a 1031 exchange.

Is that correct, if so, is there a creative way around it?

@Clint G. , It's all about intent - In a true flip your intent is primarily to resell.  To be eligible for 1031 your intent must be to hold for investment use.

Is there a creative way around it - not really.  Your intent is your intent.  If you want to do flips you're gonna pay the tax ...and pay and pay and pay :)

The way a flipper can use the 1031 however is to change the model a little.  Instead of buy fix flip you can buy fix rent and then evaluate to see if it's time to sell.  This will slow you down a little but if you want to speed things up a little you can buy fix rent refinance and then evaluate.  So you use the refinance to get the cash for your next investment before you sell your old property and 1031.

Lost of folks call this the Brrr method - buy rehab rent refinance, repeat.  it works.

First of all you're no longer flipping properties so you can use the 1031.  Even if you don't 1031 if you hold the properties longer than a year you'll be paying capital gains rather than ordinary income tax.

There's no statutory holding period but most folks feel comfortable with anything more than a year.  It's all how you can demonstrate your intent.

I wonder where the 1 year timetable came from when there isn't one in the tax code? One would think that advertising, purchasing landlord insurance, and renting the place out might be enough to signal intent. I imagine there's some historic precedents that have the professionals wary.

A six month timetable would be more appealing, if it were doable. Would love to hear from others who have done 1031s and the roadblocks they've encountered. Went off without a hitch? Got audited? Let's hear your stories.

@Matthew Meikle , That's a great question.  The origins of one year really come from three revenue case rulings where the judges issued their rulings by stating a time period that was appropriate (but as you know it would have been only strictly applicable for that case).  The three phrases used by the judges were "two years", "two tax years", and "two calendar years".  As you can imagine the attorneys had a field day with that - using those three terms a hold period of anything from 2 days to 730 days would be appropriate.

In an effort to provide guidance my industry began a mantra chant back in the early 2000s - "one year and one day".   The reason is because one year and one day always meant (in the old days) that any gain would be a capital gain (over one year).  It meant that no matter when you bought the old property you would have held it across two calendar years.  It would be reported on two consecutive tax returns.  And it was just really catch and cool to say :)

But it has no bearing on reality at all.  I'm aware of hold periods of days that have not been challenged.  And I know of several cases of multi year holds where the exchange was disallowed because the Service said the exchanger had not demonstrated their intent to hold and were in fact trying to sell the entire time.

So as ishy and squishy and gray as it is - Your intent is the standard. And your right - the things that you describe would be awesome ways to demonstrate intent. But what if you did all of those things and forgot to bring down the listing of that property on the MLS or kept the sign up in the yard because insurance is cheap and cancelable and the rentor was a friend of yours???

Most folks feel very good with anything more than a year.  But there could always be instances where a hold of less than that (or more than that) would be appropriate.  Just remember it's all about how you can demonstrate your intent.  And what is a
"fortunate accident" once becomes maybe something different when the same "accident" happens 7-8 times a year :)

Originally posted by @Matthew Meikle :

I wonder where the 1 year timetable came from when there isn't one in the tax code? One would think that advertising, purchasing landlord insurance, and renting the place out might be enough to signal intent. I imagine there's some historic precedents that have the professionals wary.

A six month timetable would be more appealing, if it were doable. Would love to hear from others who have done 1031s and the roadblocks they've encountered. Went off without a hitch? Got audited? Let's hear your stories.

Tax cases. 

If something isn't specifically stated in the tax code then we get guidance when someone tries something and the IRS does or doesn't allow it. 

We've had 1031's for close to 100 years in the tax code- the overall guideline at this point is 1 year. 

You need to prove intent at 3 points. When you buy, when you hold, and when you sell. 

If you have flipped 5 properties this year and this property seems exactly like the others but you rent it for 6 months- your intent screams flip. 

If you're a "dealer" status per the IRS with regard to your general business- you're disqualified from 1031 and installment sales. 

 

@Clint G. Your intent behind investment needs to be clear; that's what the IRS looks at. To qualify for a 1031 exchange, you must prove that your intent is to primarily resell the investment property and you will hold the replacement property for use in trade, business, or for investment purposes.

@Clint G.  

  • Under (current) Section 1031, tax deferral is available for the exchange of real property held for productive use in a trade or business or for investment.
  • Also, real property held primarily for sale is specifically excluded.
  • No direct specification of the holding period requirement period is made in the tax code.
  • In general, the courts have been more liberal than the IRS in defining what qualifies.
  • Technically, properties can be segregated and categorized with a single taxpayer holding some assets primarily for sale and others primarily for investment.

Without foresight and planning, a serial flipper is not well-positioned to challenge the IRS on this matter.

I appreciate all of the advice here! It doesn't sound like I can 1031 a flip. I'll keep this in mind in the future and hold and rent for a while before selling if I don't need the cash in hand quickly. 

Thanks again!

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