Can I do a 1031 on a fix and flip?

Question

So I guess I misinterpreted a 1031 exchange. I purchased a property Jan 2019, a few months ago. I fixed it up and it sold this month, and is set to close May 2nd. I contacted an exchange company and they told me that I could not do it unless I held onto the property for over a year? They told me that they could do it for me, but if I was audited, I would have to pay back taxes. I just wanted to double check with the people that do this. This is the first time I have attempted a flip and I really don't want to pay that huge tax hit. Any advice would be appreciated.

Thanks

Tyler Hungerford · Answer

hey @Tommy Johnson, I think a lot of that has to depend on whether you kept the property as a rental or not. This is some information from my exchange company that I use for my clients that might be helpful for you.

Please keep in mind, the four basic requirements for a successful exchange are: • Property Qualifications – the properties involved in a 1031 Exchange must be held for business or investment purposes. • Tax Deferral – to defer 100% of the tax liability you will need to 1.	reinvest all of your cash and 2.	purchase property equal or greater in value. • Timeline – the 1031 exchange must be completed within 180 days. • Identification – potential replacement property must be identified on day 45 of the exchange.

Colleen F. · Answer

Don't do the 1031 , they are correct if your intent was to flip it then it isn't qualified for the 1031.    Basically the IRS considers intent,  if you are buy and hold and are exchanging it  then it can be a 1031 but if you are basically buying to sell which is what a flipper does they will question it and you will get hit with the taxes and maybe penalties.  Without 1031 you will pay taxes on the gain minuses expenses as regular income for this property.  So if you made 33k, your tax bracket goes up to W2 income +33k and you pay at that tax rate.  A little more complicated then that but you get the picture.  but holding it for a year costs money too.

Dave Foster · Answer

@Tommy Johnson, There is no statutory holding period.  The standard is your intent.  Property that qualifies for 1031 treatment is property you purchased with the intent of holding for productive investment use (not fix n flip).  The key is that you would have to demonstrate that intent if ever audited.  The QI you spoke to is wrong.  It is not automatic that you would pay back tax if audited and the hold was less than a year.  It does create a higher bar to demonstrate your intent.

But there are many circumstances where a shorter (or longer) hold period are appropriate. As a matter of fact your transaction does technically meet the time period suggested by at least two court rulings where they attempted to describe an appropriate holding period as two tax years and two calendar years.  In your case you will have two tax returns showing the property.  Not enough to fully demonstrate your intent maybe but income in two consecutive years isn't something to sneeze at = if you've been renting.  That's what makes it tough with your situation:  There's been only work and no income production

But beware a situation where you bought to hold but something cause you to change your intent and sell  if it happens once is a fortunate accident.  If it happens 4 or 5 times a year it starts to look like something else.

Never do something wrong just because you can get away with it.  But also never not do something appropriate just because you might get questioned.

Terra Firma · Answer

dave foster nailed it.

key quote:  'you bought to hold but something cause you to change your intent and sell if it happens once is a fortunate accident.  If it happens 4 or 5 times a year it starts to look like something else.'

I have done many 1031's and my tax guys always tell me this quote ^^^ is what determines the 'sniff test'.

Scott Matthew C. · Answer

@Tommy Johnson, @Colleen F., @Tyler Hungerford, @Dave Foster, @Terra Firma, @Rob Massopust || You guys made reading about 1031 Exchanges worthwhile! Great topic and great input by you guys! @Dave Foster Do you service in Michigan? Silly question but it’s better to ask.

Thanks again everyone for their input!

Colleen F. · Answer

@Dave Foster  no problem  just got lost reading that part of your reply.  I admit I have a little paranoia regarding the IRS but glad you have some expertise in this area to share.

Colleen F. · Answer

@Dave Foster  How does he have two tax years, He bought in January 2019 and is selling in May 2019 ?  Unless I missed something..

Rob Massopust · Answer

My accountant says 14 months to be safe especially if it covers 2 calendar years. 2 years to be safe.

Its called a 2 year flip

Even if just hold it for a year you have a much better tax implication

Dave Foster · Answer

@Rob Bianco, People actually do this all the time.  It's a very easy way to increase your return for reinvestment by 25-40%.

Yes usually if you wait a year and sell it is a capital gain.  But you want to be careful with this assumption.  If the IRS determines that your intent during the year was always primarily to resell (think like a long rehab and flip) then they can call the gain ordinary income and you would pay regular income fed and state plus maybe self-employment plus maybe the ACA surcharge - It adds up tremendously.  And even if it's still a capital gain you're going to be stuck with 25-30% fed and state capital gains tax.

But if you purchase rehab, rent for a year or so to establish your intent you can then sell and 1031 without paying any tax.  You get to take the deferred tax and reinvest for your own benefit.  And if you're impatient you can always refinance during the time you hold and use the refi to buy your next property.

Rob Massopust · Answer

2 year flip to be safe, but some are doing it within 1 year its just you might get audited and have to pay the gains etc

Can I do a 1031 on a fix and flip?

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