How Quickly Can You 1031

15 Replies

I recently closed on a 14 unit MF property in Central NC. I was able to get it at a fairly low basis and it appraised well above the contract price.

I have spoken to brokers that have told me if they being me an offer without listing I can 1031 sooner rather than waiting the usual 12-24 months.

In speaking to a few QI's there isn't a specific timeframe as the interpretation of tax code is a bit gray.

Is there a recommendation how quickly is too soon to try to 1031 into a larger property?

@John Blanton

Not sure of the time frame, there is no 12 to 24 months time period connected with a 1031. The part about listing or not listing sounds like nonsense to me. Whether a property is listed or not listed is nowhere in the 1031 code. That is immaterial - sounds like a red herring to me.

Have you asked your CPA?

@John Blanton

The QIs also know the tax code as it pertains to 1031 too.

If both your QI and CPA say ok, I believe you would be safe to proceed.

I guess the other question is: Do you think you could find a better property quickly?

I suspect doubtful, you can always trade up in a year or so or more, there doesn’t appear to be a big reason to rush.

Agreed unlikely to find a better property at this point in time, just was most curious for input on the timetable in general

@John Blanton It all comes down to your intent.  If you purchased that with the intent of holding and not primarily to resell then it is eligible  for 1031 treatment.  The key is how you demonstrate that intent.  How long you actually hold it is one way (most folks feel comfortable at anything more than a year).  But there can always be reasons why your intent might change.  And the unsolicited offer to purchase is one of those situations @Arn Cenedella .  John purchased the property intending to hold it but an offer came in unsolicited that he couldnt refuse.  The fact he wasn't trying to sell and the offer is so strong could all be factors why John's intent might change.  The unsolicited offer is a hard card to deny.

Regarding availability of replacement property John you're in excellent position to utilize a Reverse exchange at this point.  Find a good replacement property and then that actually becomes a factor in changing your intent as well.  Get an offer on the table, find a good replacement and then execute the sale and purchase.  OR purchase the replacement in a reverse exchange and then accept the offer for the old property.

Good position to be in.


Thanks for the insight @Dave Foster !! Intent...that was the word I was searching for. I will keep my eyes peeled for any potential replacements if the exchange were to make sense. Thanks!

@Dave Foster

Yes intent is part of it. Of course that becomes a grey area. In this case it appears the broker does not have an offer in hand. The broker suggests a way to create an appearance of intent by saying don’t list and we will bring you an offer. 

As I noted earlier if John’s CPA and QI “sign off” on this approach, I believe John is safe to proceed.  

None of this matters unless John is audited and his exchange looked at closely. Odds are there is no issue. 

With Covid reducing tax revenues, I see tax authorities becoming more aggressive in collecting taxes. We are already starting to see this at the property tax level where assessors are being very aggressive in raising assessments. 

I just saw a large syndication in Austin TX fall apart because operator got word the assessment on their contemplated purchase was going to be 20% higher than anticipated. It killed the deal. 

We also hear tsk of eliminating the 1031. I personally don’t think it will happen but you never know. 

John is going about this the right way. Get lots of opinions and then make the call. Ultimately reliance should be given to his professional team. 

@John Blanton it needs to be "held for investment". When you are selling a property after holding it less than one year, that is considered flipping. Flipping is subject to short term capital gains. You will need to provide more than your word to prove your intent changed. 

Probably the bigger concern is that the short holding period will invite an audit. IRS is horrible to deal with. Ever tried telling an accountant they are wrong?

The brokers telling you it is ok are not attorneys and stand to profit from you selling. If you wind up in an audit, the brokers have nothing to lose. 

My opinion, holding a property for one year isn't a big deal. The property will likely be worth more in a year, plus you will have a years worth of cash flow showing on two years of tax returns to substantiate it was held for investment. 

@Joe Splitrock , as far as we can tell 1031s of any type are not an audit trigger.  So there is no initial red flagging of short hold 1031s.  Now if John is ever audited for something else then they will look at the 1031.  At that point the 1031 will be looked at.  If he closes his sale in 2021 then he bought and sold in different tax years which actually satisfies a the ruling in a couple old court cases.  So optically the two consecutive tax years may be enough by itself. 

But at the end of the day it will be his demonstrated intent if ever questioned.  @Arn Cenedella , I once asked a guy if his property was for sale - and he said "nothing I own is for sale". But for the right price anything I have could be bought.  I don't think that him giving a pie in the sky number to a broker who is crazy enough to pitch it to buyers without a listing  has to negate his intent.  It's highly conceivable that the property was designed to appreciate to XX amount in 5 years and be sold.  So if it reaches that goal in one year does that mean that his original intent was resale, or is he a talented and lucky guy?  

I wouldn't call it gray just because that indicates a spectrum between legal and illegal. I'd call it murky :). Because there's so many things that go into demonstrating intent including what side of the bed the auditing field agent got. up on the day of the audit :)

@Peter Nikic , Sec 1031 defers gain and makes no specific distinction between short term gain and long term gain.  There is an understood notion that a property held longer is more likely to have been purchased with the intent of  holding long term.  But that is only one demonstration of intent.

I did an exchange for a Bigger Pockets member a few months ago.  I'll let him chime in here if he wants.  He had only owned the property for a couple of months.  That would have definitely made his gain short term.  Why was he able to do that?  Because he and his accountant agreed that they could demonstrate his long term intent satisfactorily.

I asked how the heck they could do that - Turns out the sale contract had an addendum requiring him to honor the long term lease of the tenant. That's not a bad demonstration of intent to start off with.

" So why didn't you honor that in reality", I asked.  

"The tenant moved, he said.  

"Why", I said.  

"It was the bear that took up residence at the trash cans", he said.  

Turns out he and his accountant both decided that losing a tenant to a squatting black bear was a valid reason to change intent.  

Life can get a little strange!!!

Originally posted by @Dave Foster :

@Peter Nikic , Sec 1031 defers gain and makes no specific distinction between short term gain and long term gain.  There is an understood notion that a property held longer is more likely to have been purchased with the intent of  holding long term.  But that is only one demonstration of intent.

I did an exchange for a Bigger Pockets member a few months ago.  I'll let him chime in here if he wants.  He had only owned the property for a couple of months.  That would have definitely made his gain short term.  Why was he able to do that?  Because he and his accountant agreed that they could demonstrate his long term intent satisfactorily.

I asked how the heck they could do that - Turns out the sale contract had an addendum requiring him to honor the long term lease of the tenant.  That's not a bad demonstration of intent to start off with. 

" So why didn't you honor that in reality", I asked.  

"The tenant moved, he said.  

"Why", I said.  

"It was the bear that took up residence at the trash cans", he said.  

Turns out he and his accountant both decided that losing a tenant to a squatting black bear was a valid reason to change intent.  

Life can get a little strange!!!

 I think the comparison to short term versus long term capital gains is valid in the context of how the IRS defines an investment. If I sell a property under one year, it is subject to short term capital gains. Regardless of what my intent was, they assume my intent was to sell for profit as a "dealer". If I hold it over one year, it is considered a long term investment. There is logical rationale to say one year is an IRS recognized long term investment point.

People also cite the IRS letter PLR 8429039, which referred to two years being sufficient holding period. I think this is where people come up with the 1 -2 years as being reasonable.

I follow the logic on using intent as a loophole, but if "getting an offer I couldn't refuse" is enough to prove change in intent, anyone could argue that. The only reason you would use a 1031 exchange on a short term investment is to protect gains. My point is using this logic, anything would qualify, which obviously isn't the case.

No doubt people use the intent wording as a loop hole. It is fine if a CPA is confident it will hold up, but who pays the bill if they are wrong? Most conservative CPA will not advise trying to exploit this as a loophole. My point is just why take the risk, when you can hold it a few more months and be in a safe zone? 

I guess I am more interested in hearing stories about people who sold in under a year and cases where it went to court. That is the real test.

It comes down to risk tolerance. People do some really edgy stuff on their taxes and sometimes they get burned. 

Originally posted by @John Blanton :

Agreed unlikely to find a better property at this point in time, just was most curious for input on the timetable in general

Dave Foster and others are experts but as a 1031 Exchange agent, a general seemingly safe rule of thumb is a year and a day. More than that if you are more risk averse, less than that if you enjoy taking risk, have an iron clad reason for selling early (sold off market, made you an offer you couldn't refuse, got a great deal, collected rent, had a five year business plan etc...) Hope that helps...and great to see you on here and linkedin!

 

Well said @Alex Olson .  A blast from the past :).That was actually the mantra of the industry for a bunch of years from 96 through the last crash - One year and one day!!  It's catchy and pretty darn safe.  But unfortunately not entirely true.  A very few cases in the 2000s cast just enough doubt that it drove financial and accounting professionals back to either the ultra conservative 2 year approach (by the way not guaranteed either given the 2014?? ruling against a property owner who had an exchange disallowed on a property he had owned for 10 years over intent), or the tedious kind of scary process of self determination of intent.  

Bottom line - This is why financial and tax advisors exist - they know your whole picture and can asses how your body of intent evidence stacks up.  Never do any anything just because you can "get away with it".  But also, don't not do something you know to be right just because it might be questioned.

And above all else - It's almost always cheaper to agree with the IRS if they disagree with you than it is to fight em