SECTION 1031 INTENT
Section 1031 Intent is the most misunderstood concept in all of Real Estate Investing when using a Section 1031 Like Kind Exchange.
Because of the large amount of misinformation on blogs and real estate forums, there is a widespread belief that when you buy real property, you must also formulate in your mind, at that time, what your future intentions are regarding the disposition of the property.
It gets worse.
The “believers” further claim that if your intent was to fix up the property and sell it, then you are a Dealer, and:
* Your profit when you sell the property can never be classified as Long Term Capital Gains,
* The income when you sell the property, even ten years later, will be ordinary income,
* In addition to the income being ordinary income, it will also be subject to 15.3% self-employment tax, and
* You can never use this property as the Relinquished Property in a Section 1031 Like Kind Exchange.
All of this is totally incorrect!
If you held the investment property for at least a year and a day, when you sell it, the profit is Long Term Capital Gains.
If the profit is Long Term Capital Gains, you can defer the taxes by entering into a Section 1031 Like Kind Exchange if the property was “held for productive use in a trade or business or for investment.”
1031 INTENT IS IRRELEVANT
It is completely irrelevant why you bought the property that you are selling in a Section 1031 Like Kind Exchange, assuming that you even had a definite (or even vague) idea about that at the time.
The test of whether property is held primarily for sale or for investment is applied at the time of the Exchange.
The ruling case on this issue is Cottle v. Commissioner, 89 T.C. 467 (1987) which said:
“The purpose for which a taxpayer holds property at a particular time is, of course, subject to change. But generally it is the purpose for which the property is held at the time of sale that determines tax treatment. Daugherty v. Commissioner, 78 T.C. at 629; Biedermann v. Commissioner, 68 T.C. 1, 11 (1977).”
This is easy enough to understand, but to make it even more clear, let’s do a complete analysis of the question.
If you are not familiar with any of the terms, refer to our Dictionary.
It's Like A Seminar In A Book
IF YOU USE A DELAWARE STATUTORY TRUST, TRIPLE NET LEASE, OR A T-I-C, YOU MUST HAVE THIS EDITION.
SUMMARY: There is nothing in the Internal Revenue Code, Tax Court cases, or on IRS tax forms and/or Instructions that would support the claim that “intent” at the time of purchase of Relinquished Property is relevant in a Section 1031 Exchange. In fact, there is a Revenue Ruling and two Tax Court cases that say exactly the opposite.
READING TIME: 5 minutes, 10 seconds.
INTENT IN SECTION 1031
Always start by reading the Code. It says:
(1) In General – No gain or loss shall be recognized on the exchange of property held for productive use in a trade or business or for investment if such property is exchanged solely for property of like kind which is to be held either for productive use in a trade or business or for investment. (Emphasis added).
Section 1031 continues on for more than three thousand words, including footnotes, and none of those words is “intent” and none of the sentences say anything about what was supposedly going on in your mind at the time of purchase.
So, if the question should ever come up, between you and the IRS, how would you prove that the Relinquished Property was property held for productive use in a trade or business or for investment because of something in your mind at the time that you bought it?
1031 INTENT IN REPORTING RENTAL INCOME
If your income property was rental property, and it probably was, it was reported either on your Schedule E, or on your Schedule C, of your Form 1040, if you are an individual.
Neither Schedule E nor Schedule C have a place on the form for you to tell the IRS what was in your mind when you bought the property.
At the time you decide to use this property as your Relinquished Property in a Section 1031 Like Kind Exchange, you will probably have two annual tax returns showing this income property on them.
This is because you must have held it for at least a year and a day in order to qualify for Long Term Capital Gains treatment, and a year and a day will necessarily cover two tax years.
(The IRS computer system that processes tax returns does not have an internal audit program that matches Section 1031 sales to rental income reported on tax returns, but if they did, this is where they would look.)
So, maybe the question is does this imaginary “intent” have anything to do with qualifying for Long Term Capital Gains treatment?
I hope you are enjoying this free content.
The remainder of this content, plus additional content, is available in my book “How To Do A Section 1031 Like Kind Exchange: Simultaneous, Delayed, Reverse, Construction” available at Amazon.com/dp/B01MY433L6.
And if you are dealing with a Triple Net Lease, Delaware Statutory Trust, or a Tenancy-In-Common property, you need the OMNIBUS EDITION at Amazon.com/dp/B07BJLZNZN.
Or you can see all ten of my books on Real Estate Investing at Amazon.com/author/michaellantrip.
And I am re-writing all of this content for use on my Blog at MichaelLantrip.com, where it has already started appearing.