When buying property in a 1031 Exchange, there are a few things to consider to ensure your exchange goes smoothly and you won’t run into any problems with the IRS later:
If you are choosing to purchase a piece of land (which is always considered held for investment) or a commercial unit, you typically don't have to worry about your property being considered as held for investment. However, if you are purchasing a dwelling unit such as a home or a condo, you want to consider how you plan on using the property. In order for the property to be considered investment, it needs to be income producing, meaning there will need to be some time during the period you own it that is rented to tenants at fair market value. You may even choose to follow the safe harbor rule to avoid any doubts with the IRS, which although it may not work for everyone, is a good option.
Safe Harbor For 1031 Exchange
If you intend to purchase the property for a quick fix and flip, you may not want to do a 1031 exchange as that is frowned upon. If the IRS sees you did a 1031 with the intention of a fix and flip to defer the short-term gain, they could disallow the exchange. We recommend to our clients they hold their property for a year and a day or more. This shows long-term gain, which could prevent the IRS from disallowing your exchange.
In order to defer all of the capital gains tax from the sale of your old property, you will need to purchase at the same price, or higher, as your old property. For example, if the net selling price of your old property was $300K, you will want to purchase your new property for $300K or more. If you chose to buy down at $250K, the extra $50K would be considered “boot,” and that amount would be taxable.
Be aware! Proper title holding is one of the 6 rules in a 1031 exchange, and failure to follow this could blow your whole exchange. When taking title to your new property, you will want to do so in the exact same manner you held title to the old, meaning the tax payer on the old property must be the same tax payer on the new property.
1031 exchanges are very time sensitive, so it's important that you and your QI are aware of the deadlines for your exchange. In a 1031, you have 180 days from the closing of your old property to close on the new property. For example, let’s say you closed on your old property on March 1, 2016. You would then have 180 days to close on the new property. Since these are calendar days, meaning holidays and weekends don't count, you would need to close on your new property by August 28, 2016-- a Sunday. If you could not close on your new property by then, you may need to consider buying a different property from your 45-day list you can close on before your 180th day. |
