How Long Do You Have To Hold Property in a 1031 Exchange?

How Long Do You Have To Hold Property in a 1031 Exchange

The 1031 Exchange is one of the most potent tax-advantaged tools available to investors and owners of real estate. A 1031 exchange or “like-kind exchange” is an investment strategy that allows people to sell a property and buy another similar asset from the proceeds of the first sale without paying capital gains taxes on the profits. 

To qualify for tax deferment, you must adhere to specific regulations the Internal Revenue Service (IRS) set. 

Rules for 1031 exchange properties are clearly laid forth by the IRS. To be eligible for the 1031 tax deferral, the replacement and the relinquished property must be designed for and utilized as investment properties. However, the duration for holding either investment property to qualify for the exchange is not so simple. The only clear ownership condition is that both properties must be kept for a “sufficient amount of time,” which, in the event of a potential concern, is ambiguous in nature.

In addition, many investors have received information about the holding period that needs to be revised or, worse still, is wrong. Below, we’ll give you more information and insight into the matter to clear things up. Keep reading!

How Does a 1031 Exchange Work?

Under IRC Section 1031, investors can exchange an investment or commercial property for “like-kind” property. This method of deferring the payment of capital gains tax on the sale or acquisition of investment property allows the investor to use the revenue from the sale to buy replacement property. In a 1031 exchange, the profits from the relinquished property or the original investment must be transferred to a QI (qualified intermediary) for the investor to fulfill the conditions of the code 1031 and defer capital gains tax.

If the exchanger or investor reclaims the sale profits, they will lose all 1031 tax advantages. 

After the old property has been sold, the investor has 45 calendar days to inform the QI of any assets that could be considered replacements. Without these replacement properties, the exchanger will not be eligible for a 1031 exchange. The 180-day rule is another requirement of the exchange, which states that the exchanger must obtain the replacement asset within 180 calendar days of the original investment property sale or before the deadline for paying taxes (including extensions) for the tax year in which the relinquished property was sold.

When handling 1031 exchanges, it’s crucial to talk with a knowledgeable advisor. You may also need the help of an experienced attorney to better comprehend your rights and obligations in the transaction.

How Does a 1031 Exchange Work

Holding Period Conditions for 1031 Exchanges

According to an IRS Private Letter Ruling, a two-year minimum holding period would be considered appropriate. Many experts agree that two years is a prudent holding term, assuming that no other material considerations militate against the investment objective (even though a private letter ruling doesn’t establish legal precedent for all holders). Other consultants advise investors to hold their properties for at least twelve months.

This is due to two factors:

  • An investor would often report a property as an investment in two tax filing years if they have held it for 12 months or longer.
  • A one-year holding period was proposed by Congress in 1989. While it was never included in the tax legislation, this suggestion serves as a suitable baseline standard.

The IRS is more concerned with a taxpayer’s intent when you engage in a 1031 exchange than anything else.

The Treasury will consider several factors when looking at a case involving a 1031 exchange, time being only one of them. Even while holding duration could be considered, the main focus is on the intended use of both properties.

The IRS has made various judgments declaring that if the property to be exchanged was purchased right before the exchange attempt, the taxpayer would be considered to have bought that property principally for resale for profit and not retained for investment.

The IRS has also stated that replacement property does not count as being retained for investment purposes under IRC section 1031 if it is sold right away after the transaction.

Assessments That Regulate Holding Periods for an Investment Property

1031 exchanges are the subject of a case-by-case IRS investigation. Although the holding period is not clearly regulated, the IRS has ruled that two years is adequate to satisfy the qualified use test. But some even more liberal court rulings have been made in the past.

According to the divergent views of the IRS, courts, and legislators, it will be decided on a case-by-case basis whether or not a property is kept for investment, taking into account all of the relevant details and situations pertinent to the taxpayer’s unique position. 

Replacement and Relinquished Properties

In the event of an audit, it will be the taxpayer’s responsibility to demonstrate that holding the property for investment purposes was their intention at the time they acquired the replacement property or acquired ownership of the relinquished property. 

Additionally, many tax consultants advise owners of 1031 exchange properties to retain them for at least a year and keep other records of spending, amortization, rental revenue, and other accompanying documents of their usage as investment properties. Your replacement property must also comply with the safe harbor regulation of the IRS, which has its own specifications, whether you want to use it ultimately as a second or primary residence.

Timing and Deadlines for 1031 Exchanges

Timing and Deadlines for 1031 Exchanges

The exchange process depends on deadlines. Within 45 days of relinquishing their assets, investors must locate replacement properties and have 180 days to close on them. A disqualified trade might occur if either deadline is missed.

Investors would be advised to modify their stance on the exchange procedure if they are unsure how long they will be required to hold their replacement assets before transferring them. In this case, intent rather than time is essential.

The numerous restrictions for 1031 exchanges are outlined in IRS Code Section 1031. The Internal Revenue Code stipulates that a property swapped that is being held principally for sale would not count as a like-kind exchange, even though it does not specify a specific period during which exchangers must keep onto their replacement properties. To put it differently, investors are not permitted to sell one investment property, defer capital gains via a 1031 exchange, and proceed to fix and flip the property that was traded in.

The purchase of replacement assets must be made with the intention of using them for investment purposes. According to a 2009 IRS regulation, while trading an asset kept for trade, company, or transaction for another like-kind property utilized for a similar function, the exchangers shall not incur any gain or loss.

The Bottom Line 

So, how long do you have to hold property in a 1031 exchange? As we’ve seen, the answer is somewhat ambiguous, however a two-year holding period has been considered an acceptable holding period by past IRS rulings.

Although 1031 exchanges can be highly advantageous for investors, they can also be tricky to complete. If you’re considering a 1031 exchange, you should get professional advice to ensure you won’t be denied and incur capital gains or other liabilities.

With years of expertise handling 1031 exchanges and several long-term NNN lease investments, the experts at NNN Deal finder will guide you through the exchange procedure without allowing significant errors to get in the way. To learn how we can assist, get in touch with us at 00-240-9094 or request your list today.

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