1031 Exchange:
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CITY 1031 EXCHANGE GUIDE |
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MESSAGE FROM BROKER/TOC
A. 1031 EXCHANGE BASICS
B. PASSING THE "PURPOSE"
TEST
C. LET'S TALK ABOUT BOOT
D. SOME ADVANCED 1031 TOPICS
B. PASSING THE “PURPOSE” TEST
1. How Do I Determine
if My Property Qualifies for Section 1031?
To qualify, property must be held by the owner either “for
productive use in a trade or business” or “for investment”
(Internal Revenue Code Section 1031(a)(1)). This is the “purpose”
test. Generally, whether you pass the “purpose” test
turns upon a question of your intent.
2. Does Section
1031 Impose a Minimum Holding Period?
Neither the Internal Revenue Code nor the regulations promulgated
thereunder evaluate “intent” by reference to holding
periods. A property’s holding period is just one of many factors
used to evaluate intent. Tax advisors typically recommend that property
be held for at least one (1) year. More conservative advisors recommend
that property be held for at least two (2) years. It is possible,
however, that property held for a short period can qualify if held
with the appropriate intent. Similarly, it is possible for property
held for a lengthy period to not qualify, especially where there
is clear evidence of intent to hold the property for a non-qualifying
purpose (such as personal use).
3. Can I Sell or
Acquire A Personal Residence as Part of a 1031 Exchange?
No. A personal residence is held for “personal”
rather than “investment” purposes. Fortunately, however,
the sale of a personal residence already enjoys very favorable tax
treatment ($250,000 capital gain exemption for individuals and $500,000
capital gain exemption for married couples under Internal Revenue
Code Section 121 applies where the property sold was occupied as
a principal residence for at least 2 of the previous 5 years). Some
taxpayers have purchased residential structures, rented them as
an “investment’ property for several years, and then
moved into them for several years to take advantage of the Section
121 exemptions (where a residential structure is acquired with 1031
proceeds, a 5-year holding period now applies before you can benefit
from the Section 121 exemptions).
4. Can I Sell
My “Second Home” or “Vacation Home” as Part
of a 1031 Exchange?
Generally, a “second home” or a “vacation
home” will not qualify under Section 1031, except where the
personal use of the property is minimal. For federal tax purposes,
a taxpayer cannot claim tax deductions associated with the “second
home” investment if the taxpayer uses the property for personal
purposes for more than 14 days (or more than 10% of the time it
is rented). If an investor’s personal use is truly minimal,
then the property can very likely qualify for Section 1031. Note
also that it is possible to convert real estate used for personal
purposes into real estate that qualifies under Section 1031, where
the owner abandons the personal use and subsequently holds the property
for investment purposes.
5. Can
I Trade a Farm for a Skyscraper under Section 1031?
Yes! This fact is surprising to many investors who have only limited
familiarity with Section 1031. Almost all investment real estate
is “like-kind” to other investment real estate. Thus,
as part of a 1031 exchange, you can trade a farm for a skyscraper,
an office building for a retail center, an apartment building for
a hotel etc.
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