What Is the 1031 Exchange Holding Period?

The 1031 exchange holding period refers to the time frame between purchasing a property in an exchange and selling it again. The IRS requires that investors keep properties for a specific time to ensure that they’re really purchased as an investment—not as a flip.

While estimates can vary, most experts believe that the 1031 exchange holding period should last for at least two years. This safe time frame, accompanied by plenty of paperwork, can prove that you used an exchange in the proper manner. If you’re questioned down the road, you’ll have your documentation in place.

1031 Exchanges in Brief

Before we dig deeper into how long you must hold a property purchased in an exchange, let’s recap what these transactions are and how they work.

A 1031 exchange is a special type of transaction that can save investors a great deal on their potential capital gains taxes. As the IRS explains, most people pay a tax when they sell properties and make a profit. In a 1031 exchange, investors sell one property and wrap those tax obligations into a new property in a like-kind exchange. The associated taxes aren’t forgiven, but they are deferred until the investor sells the replacement property.

A 1031 exchange is designed for investment properties, so the IRS requires proof that the replacement property is indeed part of some type of business venture. A holding period makes that possible.

What Is the 1031 Exchange Holding Period?

As part of a 1031 exchange, an investor sells one property and purchases another. The 1031 exchange holding period refers to how long the investor must keep the property that was purchased in the exchange.

The IRS explains that the tax benefits are nullified if it’s determined that the investor purchased the replacement property just to sell it immediately (rather than using it as a true investment). The IRS will examine the taxpayer’s intent and the surrounding circumstances, and if the authorities think you’re not using the property as an investment, a tax bill could quickly follow.

The IRS has hinted that holding property for at least two years is enough to prove the intent to use it as an investment. In most cases, that’s enough. However, holding the property for an even longer period might be wise.

It’s important to note that this isn’t a hard-and-fast rule. In some cases, you might be required to hold the property for an even longer period to ensure that the IRS believes that you truly used the property as an investment. However, selling before the two-year mark likely isn’t smart.

What Happens if You Sell Too Fast?

If you don’t pay attention to the 1031 exchange holding period, you could face very serious tax consequences.

Here’s a scenario. You used a 1031 exchange to defer $30,000 in taxes by selling one apartment building and purchased another. In six months, you sold the second apartment building in another exchange. When the IRS finds out, it will send you a bill for the first deferment of $30,000, and you’ll be required to pay taxes on the entirety of the second exchange too.

How to Maximize Your Holding Period

Simply marking the dates on the calendar isn’t enough. The IRS also requires that you keep good records about your investment property. For example, you must track the money you make on the property and file the appropriate paperwork. Good records might include the following:

Rental agreements
Payments accepted
Repairs you made
Taxes you paid

Keep your documents in a safe space, so you can access them when you need them. Ensure that you can prove this was an investment if you’re asked to do so. This can help you avoid an unexpected tax bill down the road.

Get Help With Your Exchange

The best way to meet a 1031 exchange holding period is to ensure that you purchase a property that you appreciate enough to keep. For example, buy a property that you know will make you money while you hang onto it for two years.

At 1031 Pros, we can help you ensure that your exchange process moves as smoothly and as quickly as possible. Each transaction is secured with dual signature requirements, and we use a unique account for each customer. Your funds are safe with us. Contact us to find out more about how we can help you today.