There is often confusion when it comes to defining what property qualifies for an exchange. Sometimes it is easier to describe situations that do not qualify. Real estate that is owned as “stock in trade or other property primarily for sale” cannot be exchanged. This type of property is deemed to be that of a dealer, which is held for sale to customers during the ordinary course of business. This type of sale is taxed as ordinary income.

SUBSTANTIATING THE INVESTMENT INTENT

The defining factor for qualification for a §1031 exchange is the taxpayer’s “intent” at the time of purchase. Was it the taxpayer’s intent to hold the property for investment? The burden of substantiating intent is that of the taxpayer’s. Here are some ways in which the taxpayer may establish investment intent:

• Advertising, promotional efforts, and other activities to solicit tenants for property can establish the intent to hold for investment.
• Conversely, advertising and promotional efforts aimed at soliciting buyers for the sale of the property would negate the intent to hold for investment.
• The listing of the property with brokers. Listing for rent establishes investment intent; listing for sale establishes intent to re-sell.
• The extent to which improvements, if any, were made to the property. Improvements aimed at securing a tenant help establish investment intent; other improvements could be argued to establish intent to re-sell. Granted, there is a lot of gray area here.
• The frequency, number, and continuity of sales. A particular taxpayer who buys and re-sells frequently might have difficulty establishing intent to hold for investment.
• The ordinary course of business of the taxpayer. Is the taxpayer typically a landlord or a dealer?

CAN A “DEALER” PERFORM AN EXCHANGE?

Simply because a taxpayer re-sells property regularly does not automatically disqualify that taxpayer from ever benefiting from an exchange. It is good practice for a taxpayer to separate his or her activities between entities. For instance, he or she may establish a Sub-S corporation for dealer activities and an LLC for longer-term hold properties. In this way, intent is easier to establish for taxpayers involved in both worlds.

REVIEW WITH LEGAL AND/OR TAX ADVISORS

As with any aspect of exchanging, we strongly advise all taxpayers, and particularly dealers, to discuss potential exchanges with their trusted tax advisor and/or attorney before moving forward with an exchange. This brief discussion only scratches the surface of the subject covered.

Ken Tharp

Providing Qualified Intermediary services for Section 1031 tax deferred exchanges all over the United States. Headquartered in Iowa, our services are available in Missouri, Kansas, Nebraska, Colorado, North Dakota, South Dakota, Minnesota, Wisconsin, Illinois, and all other states.

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