Yet another 1031 exchange question

[Bear Geiger]

I am currently working in development of raw land. In short, we by a large piece of land, make improvements, split it into smaller tracks and sell them. At one time I was told that even if I hold this property for over 12 months it was still not eligible for a 1031 exchange. Some reasons I heard were that we were not allowed to make improvements or that we couldn’t "build inventory (whatever that means).

Then I realized that house flippers do this all the time. They buy a house, renovate it to add value, hold it for 12 months then sell it. In some cases they even split large houses into smaller units.

I would like to know if anyone has ever done a 1031 on improved land.

[Dave Foster]

@Bear Geiger, an option for you to look into is to separate your land development business from your land investing side.

Your land investing side buys land to hold for the long term.  There may be some agricultural use or a house on the property that is rented.   But the purpose is to buy and hold.

Your land development business which exists to subdivide and sell lots, buys the land from the holding company.  The holding company does a 1031 and defers tax on that gain while the development company treats the land as inventory and sells lots paying ordinary income tax on the sale of the lots which is over and above the basis that was tax deferred in the holding company's 1031.

This type of "land banking" as it is called must be structured very carefully to avoid self-dealing.  And while there is some legal precedence it also needs a fine legal hand to develop the structure and entity type and composition to keep you out of the deep weeds.  But this is really the only way to work around simply buying the land and selling the lots and paying ordinary income tax on all the gain.

Your holding company buys to hold as an investment.  Your development company buys land to subdivide and sell.  Keep the two apart and you've got some 1031 opportunity.

As far as intent goes and your comparison with flippers.  There are a host of fix n flippers who have developed more of a brrrr model as popularized on this site.  They buy rehab rent refinance and hold for a period of time (usually over a year).  That lets them establish their intent to hold for productive use.  And they have the tax returns with income to demonstrate.

This is the toughest part about a land development play.  Even if you subdivided the land and put in the infrastructure (created inventory) and then held those lots for a year.  It would still be difficult (not impossible but difficult) to demonstrate that you created the lots to hold since you're not generating income from them or using them productively.

GTA (good till audited) isn't the best doctrine to hang your hat on!!