Does 1031 Impact Ordinary Income From Sale of Rehab Property?

[Brandon Sturgill]

So, my CPA indicated that a 10301 really won't assist in deferring capital gains because capital gains are irrelevant when selling a short-term investment. His explanation is that the profit will be taxed as ordinary income irrespective of the desire to use 1031...is this accurate?

[Jake Hottenrott]

Qualifying for a 1031 exchange requires both properties have to be held as an investment or used in a trade or business.  Held for investment refers to future appreciation while used in a trade or business means income producing such as a rental property.  In a flip, there was never any rental income so as such it's not income producing.

Section 1031 then goes on to state that property held primarily for resale does not qualify. An example of held for resale is a developer who buys land, breaks it up into lots and sells the lots (this is a "dealer").  Also, a fix and flip where a property is purchased, fixed up and then immediately resold.  To the IRS, these are the classic examples of held for resale.

A flip can be turned into an investment in the eyes of the IRS so that you can do a 1031 exchange.  In order to do this you need to hold the property at least a year.  The IRS does not want short terms capital gains (higher tax rate) being turned into long term capital gains (lower rate)  by doing an exchange during the first year.  The IRS also wants to see the property bought in one tax year and sold in another tax year.  This requires holding a year and a day.

So the short answer to your question is that no, you can't use a 1031 exchange when selling a short term investment.