Are Short-Term Capital Gains 1031 Eligible?

[Nick Gray]

Hi, I purchased an 8-unit set of townhouses in Seacoast New Hampshire in September 2020 and renovated all 8 units from October to January. The total project cost was ~$1.0M and now, based on current income/expenses and an 8% cap rate, the property has appraised for $1.350M. To raise capital for my next acquisition, I am refinancing the property with a higher loan principal and also contemplating the sale of 30% equity to a few limited partners. 

If/when I sell 30% of the equity, my presumption is that I will incur a capital gain of ~$105K (0.3 x ~$350K). Because I have only owned the property for ~6 months, those funds will be a short-term capital gain and will be taxed as ordinary income. Are those short-term capital gains eligible for a 1031 exchange, assuming that I satisfy all other 1031 requirements? Or are only long-term (>1 year hold-time) eligible for a 1031 exchange?

[Sean Ross]

Happy Monday @Nick Gray, and hello Manchester (a really cool place!)

There is no specific statutory holding period for a property to qualify as "held for investment" in a 1031 exchange.  The IRS (and the regulations) care most about "intent" and pattern. 

You may hear some advisors suggest only 1031ing properties held for 12+ or even 24+ months. But this is the height of caution.  Time held is only one factor that determines your intent as an investor. 

If you make a habit of buying and selling too quickly, the IRS could deem you a "developer" and suggest that your property is "inventory" rather than real property held for investment.  But if your fact pattern is different (maybe you have several other properties held for long-term use), then you are in good shape to do an exchange. 

Be careful about how the sale and any future project are structured; partnership interests are not eligible for 1031 tax deferral. 

Hope this helps,