What Does Intent Have To Do With A 1031 Exchange?

The IRS is strict when it comes to approving legitimate 1031 exchanges. One area where they pay special attention is intent – specifically that of the investor. In particular, the actions of the investor before and after a transaction will often be scrutinized. In order to qualify for a 1031 exchange, both the relinquished property and replacement property must have been acquired and “held for” investment or use in a business or trade.

Although the IRS has imposed this “held for” requirement, the IRS does not bother to note in the Code or Regulations the amount of time required to satisfy this requirement. Instead, the IRS has simply adopted the position that if an investor either acquires property immediately before an exchange or disposes of property immediately after an exchange, the “held for” requirement is not met and the exchange fails.

The IRS has issued a Private Letter Ruling (Ltr Rule 8429039) that states two years as adequate; however, this ruling is not mandatory. This lack of a safe harbor holding period puts an investor at a disadvantage, since the IRS interprets 1031 compliance based on the investor’s intent, which is subjective. According to the IRS, intent is based on the facts and circumstances surrounding the acquisition of ownership, as well as what the investor does with the property while he or she owns it.

Some investor actions trigger immediate IRS scrutiny, such as:

• Acquiring replacement property and immediately listing it for sale.
• Acquiring replacement property and immediately transferring ownership to a corporation, partnership or LLC
• Receiving relinquished property by deed from a partnership and then immediately selling/exchanging the property
• Acquiring replacement property and immediately converting it to a personal residence

When challenged, the burden is on the taxpayer to prove intent that complies with the somewhat ambiguous “held for” requirement.

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