At the end of a successful 1031 exchange, you’ll have a new property in your portfolio. How long do you have to hang onto it?
The answer isn’t clearly defined in formal documents created by the Internal Revenue Service (IRS). However, a careful reading of printed pieces can help you understand how long you must wait before you put your new property up for sale.
What Is a 1031 Exchange?
A 1031 exchange is a coordinated transaction investors use to sell one property and purchase another. In a standard 1031 exchange, an investor chooses one property to sell and hires a qualified intermediary to hold the funds. Then, the investor chooses a property to purchase, and the qualified intermediary releases the funds for the sale.
In a transaction like this, the IRS explains, the investor rolls the tax obligation from the sale into the new property. The debt is deferred, but it’s not forgiven. When the investor sells the new property, the tax is due.
An exchange like this is designed for investors only. It’s not made for people who want to buy things like primary homes. This is where the holding period comes in.
What Is a 1031 Exchange Holding Period?
IRS rules require that 1031 exchanges involve property that’s used exclusively for business or an investment. That means it must remain part of your portfolio. If you flip the property, give it away, or transfer it into your personal possession, the IRS may believe that you didn’t enter the exchange with pure intentions.
So how soon can you sell a 1031 exchange property? The IRS has clear rules involving just one type of exchange. If you purchase a property with an exchange with a related party, you must hold it for two years before selling it again.
Some exchanges don’t involve related parties. In fact, it’s safe to say that many of them do not. However, it’s reasonable to consider a two-year holding period safe for all types of these transactions.
Is This Time Frame Firm?
The two-year time frame we’ve mentioned is firm in exchanges involving related parties. It’s not firm in other types of exchanges, although it’s reasonable.
IRS documents state that the authorities examine “the taxpayer’s intent and the surrounding facts and circumstances” when trying to determine if people have held the property long enough before they sell it. That means they look for a paper trail that proves you purchased the property as an investment and actually made money on it.
Sticking with a time frame is a quicker and easier plan. If you hold the property you purchased for at least two years, it’s less likely that the IRS will question your intent and ask for proof.
What if You Need to Sell Sooner?
Investments can be unpredictable, and sometimes, the plans you make don’t work out. While you might purchase a property with the intention of keeping it for at least two years, you may need to sell it sooner. What can you do? The work starts when the sale is complete.
Ensure that you keep very good records about your investment and file the appropriate paperwork with the IRS every year with Schedule C (Form 1040). Confirm that the officials can pull up your records and understand that you had good intentions when you purchased the property.
Before you sell, talk with a lawyer about the risks and benefits of selling your change property. You might find that waiting could help you to save money on taxes while protecting your portfolio. Don’t make any decisions without exploring all of your options first.
Who Can Help You?
A 1031 exchange can help you diversify your portfolio and purchase a new property. However, the investment you make should stay with you for years. It’s much harder to sell these properties when you’re done with them. If you’re accustomed to flipping properties often for a quick profit, an exchange may not be the right choice for you.
At 1031 Pros, we specialize in these transactions. We can help you understand how they work, what they are for, and why they can be profitable. If you choose to begin one of these deals, we can work as your qualified intermediary and ensure everything happens as it should. We’ve helped investors just like you, and we’d love to get started. Contact us today to find out more.
References
Like-Kind Exchanges Under IRC Section 1031. (February 2008). Internal Revenue Service.
Exchanges Under Code Section 1031. American Bar Association.
Info 2009-0060. (March 2009). Internal Revenue Service.
2023 Instructions for Schedule C. Internal Revenue Service.
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