1031 exchange or show income for bank loans

[Clayton Smith]

I purchased a property earlier this year that was in terrible shape and I believed it was a teardown so I got it for the land value. I planned to BRRRR the property. I cleaned the property and lot up and repaired the structure and it was not in as bad as shape as I originally thought. I got a cold call from a fellow investor and I threw out a high purchase price and he agreed. So I stand to make just under a $25k profit selling the property. I started my LLC last year and this will be the first time I show income and would like to finance my deals based on my LLCs income and not personal in the future.

My question is do I show the income on my taxes to help with loans or do I 1031 exchange the property and defer the taxes? Since I just bought the property I have not claimed any depreciation. This will be my 3rd flip this year so I will show around $75k in income plus my rental cashflow. Just want to get some advice on how to move forward. I have talked to my CPA and he said since the buyer contacted me unsolicited it will meet the 1031 rules on intent of the investment when purchased. Any advise would be great.  

[Joe Splitrock]

Originally posted by @Clayton Smith:

Originally posted by @Joe Splitrock:

Originally posted by @Clayton Smith:

I purchased a property earlier this year that was in terrible shape and I believed it was a teardown so I got it for the land value. I planned to BRRRR the property. I cleaned the property and lot up and repaired the structure and it was not in as bad as shape as I originally thought. I got a cold call from a fellow investor and I threw out a high purchase price and he agreed. So I stand to make just under a $25k profit selling the property. I started my LLC last year and this will be the first time I show income and would like to finance my deals based on my LLCs income and not personal in the future.

My question is do I show the income on my taxes to help with loans or do I 1031 exchange the property and defer the taxes? Since I just bought the property I have not claimed any depreciation. This will be my 3rd flip this year so I will show around $75k in income plus my rental cashflow. Just want to get some advice on how to move forward. I have talked to my CPA and he said since the buyer contacted me unsolicited it will meet the 1031 rules on intent of the investment when purchased. Any advise would be great.  

 You cannot 1031 exchange a property that was never held for investment. Your CPA is giving you very risky advice that goes against legal precedence and common advice. The facts in this case do not support intent.

1. You are a flipper who has flipped three properties this year. This is your business and pattern of behavior.

2. You never placed the property in use as a rental, you never claimed deprecation and you never received rental income. It was never held for investment, not even a day!

3. The IRS has stated that two years is safe holding period for doing a like kind exchange. Some people push it down to one year, claiming two tax returns. You held this property less than one year and it was under rehab the entire time.

4. Receiving unsolicited offers has nothing to do with intent. Every investor in the world is getting unsolicited offers for properties. Every flipper is being asked "do you have other properties". Assuming your CPA is right, EVERY flipper could do 1031 on every property just claiming intent if they sold it off market. That is obviously not correct.

All of your behavior patterns show this was a flip. Regardless of what intent you try to claim, your behavior is what matters. The IRS doesn't need to prove you are lying, you need to prove that you are telling the truth. 

I guess I should have included some more information about my past investments. 

I have flipped 3 properties this year, my first flips, but I own 15 rentals. I am currently renovating two other rentals that I will hold for an investment property. I have also BRRRR'd properties in past years. I got a renovation loan on the property that will convert into long term financing once renovations were complete. I have not claimed depreciation because I just bought the property in April. I am not very far in the renovation but I have emails with my property manager talking about how much to charge for rent based on adding an additional bedroom. I understand the IRS guidelines on the 1031 but I believe my behavior does show that at the time of purchase I intended to hold long term. That is why my CPA gave this advise.

 It doesn't change my answer, because you are not satisfying the requirements of it being "held for investment" which the IRS has said short term is not sufficient. Less than a year is short term by all standard. The IRS has stated that a time period of "two years is sufficient". You also received no investment income, so your entire financial gain from this sale is due to value add (flipping). The rules say it doesn't "apply to any real property held primarily for sale". If you had no rental income, what other purpose is there than sale? Intent doesn't matter. The word intent isn't in 26 US Code 1031. 

I don't know if you will get audited, but if you do, this is very questionable at best. The burden of proof is on you and "my CPA told me it was ok" is not a defense. I am not trying to argue with you. I am genuinely trying to give you safe guidance here. It would have been better if the property was rented before being sold, because that would have show actual investment use, even if the time period was shorter.