1031 Exchange on my flip

[Michael P.]

I just entered into contract to sell my investment property that I purchased on June 2, 2015. The profit is in gross terms $240k, but with write offs, commissions and transfer taxes, I think I can reduce the capital gains liability to $175,000. I am not a real estate dealer/broker, I am a finance professional and I have a primary residence. This property is our first investment property and given an attractive offer, we've decided to flip it. I rented only the detached garages over the last 5 months and kept the 2 family unit vacant given development work we were working on. We spent about $20k developing a rebuild project that we are walking away from with the sale. My accountant is of the view that ownership less than 1 year makes it incredibly difficult to avoid the taxes. Only thing I know is that it this property was truly an investment for my wife and I. Any seasoned perspective would be greatly appreciated.

[Dave Foster]

@Michael P.  The short hold time by itself is not a deal killer for you if other extenuating circumstances warrant the applicability of a 1031.  I would caution however that you need to temper the use of words like re-development.  The Service has taken the view that developers are really in the business of creating inventory (something primarily for resale).  You introduce a new level of challenge for your intent if you use language and produce documentation that shows you were "creating inventory" rather than improving or rehabbing a rental.

Your strongest arguments will be:

1. Your lack of history as a dealer.

2. The actual rents reported appropriately and depreciation schedule set up by your accountant.

3. Your stated (interpreted as actual) intent to hold that property for productive use as an investment.

4.  The change in market and presented opportunity that compelled you to sell at this point rather than being your primary motive when you purchased it.

Don't do something simply because you may be able to get away with it.  But also, don't not do something simply because it may be questioned.

Your risk in legitimately attempting a 1031 exchange is limited to the possible failure of the exchange upon audit coupled with the associated tax.