Don't Miss This Important 1031 Exchange Requirement

If you are an investor considering a #1031 exchange, there are many pitfalls to avoid to ensure a successful exchange. One of these is the nature of the property you plan to trade.

One of the key requirements for a real estate exchange to qualify under section 1031 for tax-deferral is that the property involved was held for either investment purposes or for productive use in trade or business. In many cases, this is a fairly straightforward proposition to prove. However, in other exchanges, questions may arise as to whether this strict requirement has been met.

So how does the IRS determine the nature of the property involved? One of the main things that will be scrutinized is the investor’s intent. Of course, this is a somewhat amorphous and intangible thing to determine. Yet the IRS has some criteria that guides them to their final decision.

Although non-exhaustive (and keep in mind that every exchange is unique), the following general factors will help the IRS determine intent:

• The nature and purpose of the property acquisition
• The duration of ownership
• The extent and nature of the investor’s efforts to sell the property
• The number of sales executed by the investor
• The use of a business office for the property sale(s)
• How much control the investor exercises over the actual seller of the property (if the parties are different)
• The amount of time the investor regularly devotes to sales
• The ordinary course of business of the investor

The bottom line is that if you are an investor who regularly buys and sells properties, the IRS will scrutinize your 1031 exchange transactions differently than the investor who only occasionally trades up. That doesn’t mean that a broker cannot participate in exchanges, only that he or she must be careful to segregate that activity from day-to-day broker operations.

If a 1031 exchange is in your future, visit our website to learn more about these powerful tax deferral tools and our qualified intermediary and replacement property locator services.