Before we start into that subject, let’s cover a basic rule. Tax deferred exchanges are for Investment Properties. The legal definition of investment properties is “Real estate held for productive use in a trade or business or for investment.” What does that mean in laymen’s terms?
Let me make a confession to you. Although I work very closely with a team of attorneys, I myself am not an attorney or accountant, so I personally have to do that conversion for myself. Hopefully that also means that that I can be more clearly understood.
I have found it easier to explain investment property as property that you create income on (like a rental), operate a business on (like commercial property), or hold for appreciation (like raw land). An investment property cannot be your personal residence or second home.
From that, it almost sounds like flipping properties would be no problem. But, the IRS doesn’t feel that way.
Usually when talking about real estate, “inventory” means how many homes are available to purchase; but when talking about taxes, you are talking about the purchase of something with the intent to resell. Think about a grocery store. It purchases inventory at wholesale prices to re-sell at retail prices, which is taxed as income. The IRS determines that real estate purchased with the “intent to sell for a profit” is taxed as income. So unless property is purchased with the intent to create income or hold for appreciation, it is considered to be inventory, and when sold, and is taxed as income, not investment.
How do you prove your intent? You have to prove it with fact patterns. There is also no official “holding period”, but that can contribute to a fact pattern that would prove your intent. So, if you want to go over any specific scenarios that you believe would show a fact pattern that would prove your intent was to purchase and sell investment properties, give me a call and we can walk through them. There are certainly plenty of situations that would work in an exchange if it is planned in advance. Time heals most wounds, as long as you don’t wait too long before to talk about them.
Let’s Talk about Your Situation
These are all examples of why you should come in and talk with attorneys well before entertaining the listing or accepting of an offer on the property.
Today's blog courtesy of Kevin Hummel, CEG®
Certified Exchange Specialist®
Tax Deferred Exchange Practice Group
McFerran Law, P.S.