August 2005 - 1031 Tax Exchange Newsletter

SB&OH EXCHANGE ACCOMMODATORS, LLC
ELECTRONIC NEWSLETTER

August 26, 2005

 
Upcoming Clock Hour Class Schedule:

Easement in WA State ... 08/30/05 9:00-12:30 at The Academy instructed by Tom Oldfield; sponsored by The Academy

Short Sale/Forclosure ... 09/22/05 9:00 – 12:30 at The Academy instructed by Jeff Helsdon; sponsored by Academy and First American Title

Is The Property Held for Investment?

One of the recurring 1031 problems in hot markets such as we have now is the problem of how to characterize property that has been held by the taxpayer for only a short time, and then the taxpayer gets an offer to buy it that he cannot refuse.  Can the taxpayer effect a 1031 exchange if he has only held it for a short period of time?

Section 1031 states that a tax-free exchange is unavailable if the taxpayer has held the property as “stock in trade or other property held primarily for sale.”  IRC § 1031(a)(2)(A).  The term “primarily” means “of first importance” or “principally.” 

The language in Section 1031 is similar but not identical to the language in Section 1221 that defines the term “capital asset,” which excludes “stock in trade” or “property held by the taxpayer primarily for sale to customers in the ordinary course of his trade or business.”  The key difference between Section 1031 and Section 1221 is that the definition of a capital asset requires the property to have been held for sale to customers in the ordinary course of business, while Section 1031 does not have this requirement.   It is probably more difficult to show that a property is not held primarily for sale in an attempted 1031 exchange because the taxpayer cannot show that he did not hold the property for sale to customers “in the ordinary course of [his] trade or business” and fully meet the requirement that the property not have been held primarily for sale.

The intent of the taxpayer is measured at the time of the exchange.  There are generally three groups of facts that courts look at to determine if the property was held by the taxpayer for sale and not investment.  They are:

(1) The frequency, number and extent of real estate transactions entered into by the Taxpayer.

(2) Development activity of the Taxpayer.

(3) The nature and extent of efforts by the Taxpayer to sell the property.

The first group of facts seems to be the most important.  There is no set number of transactions that will put a Taxpayer over the top.  The more the number of transactions, the greater the chance that the IRS will find that the property was held primarily for sale, and not for investment.