Will property qualify for 1031 exchange and can I take some $ out

[Terri Dyer]

We bought a property in January with cash.  We were planning on renting it and had a couple tenants fall through.  Now spring has rolled around and we saw what local houses were selling for and decided since we didn't get it rented to fix it up a little more and sell it.  Will it qualify for a 1031 exchange since we didn't end up getting it rented?

When we do get it sold we would like to take back out the amount we bought it for and the money we put into it (we do not have a mortgage on it we bought it in cash and did all the repairs with cash).  Then just 1031 the remaining profit.  Is this allowed?

[Dave Foster]

Great question @Terri Dyer, the answer is it depends :)

Property that qualifies for 1031 treatment is property you purchased with the intent to hold for productive use as investment.  There is an implication of holding but no statutory holding period.  Most people feel comfortable with anything over a year.  However there could always be individual circumstances that might make a shorter (or longer) holding period appropriate.

It sounds like you bought it with the intent to hold for productive use.  What kinds of things can you point to that would back up that intent?  Past practice, the rental applications, conversations with your cpa, etc etc.  

I've got a feeling thought that even if you felt like your intent was solid that the 1031 still won't work for you this time.

The reason is that in order to defer all tax in a 1031 you must purchase at least as much as you sell.  The IRS doesn't just let you park profit.  You can purchase less than what you sell but you will pay tax on the difference just as if you pulled profit out of the deal.

I know, you put the money in the first time and it's not taxable.  That's right.  But when you purchase less than what you sell and take money out the IRS says that's not your original capital but profit.  They win the argument.

So if you're wanting to buy down that much I don't think the 1031 would provide you any savings.