1031 Exchange For Newly Renovated Property

[Michael Lipari]

Question I have that I can't seem to find a clear answer on:

I am going to finish renovating a property this spring, and would like to immediately sell and flip it using a 1031 exchange into more units. The renovation took place from late last year into this year. The property has not had any tenants / been rented out. The property was bought under my LLC.

Is there any Legal Consequences I may run into by attempting this?

Thanks in Advance.

[Kory Reynolds]

Quote from @Michael Lipari:

I bought this property Late August of 2023. I will be finished with renovations most likely in May of this year (2024). Based on what you gentlemen said I am thinking of selling after late August of 2024 so that I only have to pay capital gains taxes. My original intent was to use this property as a short term rental however, based on the market I can sell for a considerable profit to invest in more units and grow faster. I did not intend to do a flip at all. The LLC I purchased it in even has "rentals" in the name. Would I have to rent it out as a short term rental from May until late August to avoid being seen as a "dealer" in the eyes of the IRS?

The rental use alone won't create a position, but it isn't a bad additional fact to have. But you better make sure all your ducks are in a row, all your facts, all your documentation, everything supports that your original intention from planning, acquisition, renovation, when and how you started marketing it for sale, etc, your history of other investments - your proformas, your e-mail correspondence, etc, all pointed towards that this was an investment / business use property and not a flip.   The IRS still doesn't like "short term" 1031s, with good reason - you need to ensure that you can 100% support that it was not a flip.

This was not uncommon during 2020-2022 when prices were increasing at an incredible rate, I did have a few clients where they acquired a property that was truly intended to be a rental property, had a long history of buy / renovate / hold rentals, and then the market just blew up so fast that it changed the investment analysis for that property, or in several cases they actually just received unsolicited offers that they couldn't refuse.  Having actual rental use can support the position, but renting it for a few months for the sake of creating a position, and that the only reason you are doing it is for tax purposes, I wouldn't consider that to be valid rental time for purposes of trying to prove it was always held for investment use. Holding it for another few months also won't necessarily get you there either if it was actually a flip, but you are just trying to make it look better for tax purposes.

Summary point being - it can be a valid tax position to have a short term gain / property held for less than 2 years rolled into a 1031.  But you better make sure all your support is buttoned down tight.  Don't try and invent your facts afterwards, be very honest with yourself (and your CPA) on what your intent was from the get go and how that is supported.