1031exchange on house initially purchased to rent but now selling

[Tom S.]

I have a house that I purchased to do the BRRR method with. During the inspection period of the sale, I had a rental inspection performed on the house per my cities ordinances. I also got rental insurance on the property since that was my initial plan. The city I'm in is pretty strict on rentals and one thing the house did not pass on was the headroom at the top of the stairs going to the upstairs. At first I planned on rerouting the stairs to gain enough headroom so that it could pass the rental inspection. I have now decided that it would not be worth the money to make this modification and I have decided to flip the house instead when I am finished rehabbing. Is there any way I would be able to do a 1031 exchange in this situation? I have read that if your initial intent was to rent the property and you end up selling, that would qualify for a 1031 exchange. Would I have the necessary evidence to do a 1031 exchange? Thank you all in advance for your answers!

[Dave Foster]

@Tom S., I've only been personally acquainted with about 5 audits in 18 years.  They just don't happen that often when documentation is tight and a good QI with standing is used.  There were a couple where interpretation like this was required.  Both passed.  

But there are other situations in case law that we've seen where the exchange didn't pass.  Usually there was some other mitigating circumstances.  And in every case the 1031 was not the audit trigger. - Good motivation to keep your nose clean otherwise!

The probable worst case is paying the tax and interest.  These types of interpretive situations rarely result in penalties.