Need help- partnership flips end game- 1031 possible?!

[David Denney]

Hello, quick background- 

I have been buying and flipping raw farmland/ recreational farms for about 5 years. I'm on My 3rd soon to be 4th farm. I have grown my equity very quickly. Problem:Currently I own 1/3 equity along with my father 1/3 and our partner1/3. We do not have an LLC. We have been buying as tenants in common. My plan has been to use 1031 and build my equity until I own a farm w no morgage and it cash flows. The issue is that I'm giving up 1/3 equity to a partner and would like to only have me and my father own the final farm. I find the deals and so 90 % of the flip. We split expenses 1/3. Seems like I'm giving up a lot. Is there a way to let the partner cash out in between Farms and continue to 1031 to the next farm??? I've been. Told that to complete a 1031, the title cannot change from one farm to the next. So loosing a last name of the partner in the title would not allow me to 1031 I'f the partner cashes out; correct? This is also the reason I haven't converted to an LLC- 1031. Currently farm will be worth approximately 1 million at sale. Need some help if anyone has advice. Thank you!

[Sean Ross]

@David Denney, you've got another potential problem besides the 1/3 partner that you're keen to move on from. 

The IRS allows 1031 Exchanges to defer taxes on what they consider to be capital assets.  Most investment and business real estate qualify as capital assets.  However, properties bought and sold by flippers are not categorized as capital assets.  

If the IRS labels you a "developer", which seems like a real possibility given your investment model, then your properties switch from "capital asset" to "inventory".  And inventory does not qualify for 1031 treatment. 

There is no hard and fast line that separates flippers from long-term investors.  The most straightforward way to look at it might be "investors hold assets longer than one year", since 12 months is the time when you go from short-term capital gains to long-term capital gains.  And I know some accountants that use this as a rule of thumb.  

If you haven't been treating your properties as inventory so far on your prior tax returns, then you could very plausibly do a 1031 exchange into your next farm.  But, if you keep up a pattern of switching farms every 8-15 months, my guess is that at some point you begin to raise red flags. 

If you want to go the 1031 route, you might want to consider longer hold times.  However, this is a conversation that you should have with your CPA. 

(To your other point about title not changing in a 1031 -- yes, that's correct. You either need to buy out the partner's 1/3 before the exchange is started or after the exchange is complete.)