Is this Investment Property for 1031?

My client came to me after the fact with docs for a 1031 Exchange.
The property he sold was a condo that he held for several years and that he did not rent out. He told me his sister was living in it rent free. He did not deduct any rental expenses on it or take any depreciation on it.
He owns several more condos that he does rent out.
The "replacement" that he bought thru an exchange company is another condo that he immediately placed a tenant in.
Does this Qualify? - Assuming he met all of the other requirements of course.

Sec 1031(a)(1) says "no gain or loss shall be recognized on the exchange of property held for productive use in a trade or business or for investment ...".

Build a case for the personal use condo being investment property. What was his purpose in owning the condo? Did he acquire it for the purpose of providing a residence for his sister? What other uses has the relinquished condo had?

My understanding is that he thought condos were a good buy at that time, he bought several of them, this one is the only one that he did not rent out. So I am sure an argument could be made that he thought they were a good investment. Would like to be able to see / find some legal support for the position that it would still qualify as an investment property. Can anybody point me to anything?

Well, was it a good investment? How much did he pay for it and how much did he sell it for?

My understanding is that he thought condos were a good buy at that time, he bought several of them, this one is the only one that he did not rent out. So I am sure an argument could be made that he thought they were a good investment.

The primary purpose behind acquiring the property must be for investment. That it increased in value doesn't mean it was held for investment. What was actually done with the property indicates the intent at the time of acquisition.
Questions to ask: was his intention to rent the condo? If so, was it ever actually rented? Ever advertised for rent? When did the sister move in? The day after closing perhaps?

The court's opinion in Moore TC 2007-134 may be of help, and has lots of cites to other cases.

I think Frankly did well in providing the legal support.

Were the funds held properly in escrow by a third party intermediary? What rationale did the intermediary use to qualify the exchange? Was his intent to rent from the beginning, and he had his sister live in the home to watch over the property whilst seeking a renter perhaps?

Here's some more legal support you might find worthy:
In Reesink v. Commissioner, the petitioner sold a San Francisco apartment building for $1.4 million. Reesink put the sale proceeds into a single-family residence which he then tried to rent. When his rental efforts were unsuccessful, Reesink moved his family into the single-family residence. The IRS disallowed Reesink’s treatment of the sale and later purchase as a tax-deferred 1031 exchange. The Tax Court ruled that since Reesink originally held the residence out for rent, though only for eight months, the sale and purchase qualified as a 1031 exchange.

In Adams v. Commissioner, Mr. Adams purchased a personal residence for $26 thousand where he lived for many years. After he moved, he rented his San Francisco residence until he sold it for $600 thousand. The sales proceeds were then used to purchase a new residence in Eureka, California, which Adams rented to his son. Adams treated the sale of the San Francisco residence and purchase of the Eureka residence as a 1031 exchange. The IRS disagreed. The Tax Court held the exchange qualified as a 1031 transaction since the son paid fair rental value for the Eureka home.

Can you imagine purchasing a home in SF for $26K??? Goodness gracious gbof!!

Both cases above mention rent and the intent was to rent. If your client literally purchased the home for his sister, rent free, I can't see a 1031 exchange occurring here. But, then again, I didn't stay at a Holiday Inn Express last night....

Geez Frankly beat me by 3 minutes, unbelievable!! Nice one!

Thank you Frankly and EA Dave - very helpful!

You bet, and I bet there might be others (with brains bigger than mine) that chime in too. You just never know...

I'm going to suggest very gently that it's not the taxpayer/owner/exchanger's intent or expectation that the tax law tells us to look at, it's the actual use of the property. See IRC 1031 where it says that it's "property held for productive use in a trade or business or for investment" that's eligible for the tax-deferred exchange. All this back-and-forth about what the taxpayer's intent may have been and how we could support that intent seems like a waste of time if the actual use of the property was to provide his sister a place to live at a below-market rent. [but maybe I'm making a rash assumption in deeming the free rent to be less than market, but I've been out on a limb before...]

And if we borrow the definitions used in Section 280A, like, especially, what we find in 280A(d)(2)(C) for "personal use" of a dwelling unit, namely that "the taxpayer shall be deemed to have used a dwelling unit for personal purposes for a day if, for any part of such day, the unit is used ... by any individual (other than an employee with respect to whose use section 119 applies), unless for such day the dwelling unit is rented for a rental which, under the facts and circumstances, is fair rental."

[sound of refrigpbrerator door shutting in the next room....]

If personal use and investment use are mutually exclusive, which I've heard somewhere, I would think that the IRS would have a really strong argument (like, almost, a slam dunk) that giving free rent to anybody [and not just a relative] pretty much skewers any argument that would try to support "investment use."

Where's that rule about looking at what the owner does [not, I note, what the owner intended to do] with exchange properties during the two-year periods before and after the exchange? That rule does apply to Section 1031, no?

Where's that rule about looking at what the owner does [not, I note, what the owner intended to do] with exchange properties during the two-year periods before and after the exchange? That rule does apply to Section 1031, no?

You're probably thinking of Rev Proc 2008-16 Harry. 1031 does appear to be based on what the property was actually used for as opposed to the long-term rental vs flip/dealer decision, in which intent is a factor.

On a (relatively) unrelated note, the sister may be the client's dependent... It really depends on her gross income and other sources of support. I imagine if she is getting rent-free accommodations she doesn't make that much money...

Reesink is a good read if just for the Findings of Fact, particularly the strangulation and attempted poisoning...

Yeah, that Reesink [https://www.leagle.com/decision/intco20120423b45] case seems to pertain to our topic, but as for the "record of civil behavior between the two brothers" as pointed out in the facts of the case, the relatives' relationship would seem to be relatively irrelevant to the tax issues.

And if we borrow the definitions used in Section 280A, like, especially, what we find in 280A(d)(2)(C) for "personal use" of a dwelling unit,

If we are to borrow, we should borrow the whole thing from (d)(2)…

(2)PERSONAL USE OF UNIT For purposes of this section

That section is there just to deny deductions for personal use, or shall I say “deemed” personal use. It is odd, though, that if you read it through, one conclusion is this:

…the taxpayer shall be deemed to have used a dwelling unit for personal purposes if the unit is used for personal purposes by the taxpayer…

Hmmm, that’s interesting. If I lick a lollipop, am I deemed to have licked it? Maybe so. But I thought in the tax world that if you were deemed to have done something, you didn’t actually do it, but would be judged as if you actually did. But maybe I misunderstand. It’s confusing. Are we to take “deemed” to mean we actually did it OR we didn’t actually do it, but will be treated as if we did? If so, this means an actual act is also, and always, a deemed act.

Take a look at Section 6513(b), for example:

Any tax actually deducted and withheld at the source during any calendar year under chapter 24 shall, in respect of the recipient of the income, be deemed to have been paid by him on the 15th day of the fourth month following the close of his taxable year with respect to which such tax is allowable as a credit under section 31.

Ok, that’s fair enough. But, if we go by the way “deemed” is used in 280A (i.e. an actual act is a deemed act), wouldn’t we also say that the taxpayer is deemed to have paid the withholding tax on the day(s) it was actually withheld? I think so. That presents a massive problem, doesn’t it? We now have a multitude of dates on which the tax was deemed paid. Of course, only one of these dates is mentioned in 6513(b), but that doesn’t mean the unmentioned deemed date(s), which are actual withholding date(s), should be disregarded, no? If I’m right, which I think I am, that means we have some important tax law pertaining to Sec 6513(b) that is nowhere to be found in Sec 6513(b). But if I’m wrong, this means the one date mentioned in Sec 6513(b) nullifies and supersedes all other dates. But I don’t think I’m wrong, because it says, “…be deemed to have been paid by him on” and it doesn’t say “…be deemed to have been paid by him on, and only on…” In other words, Congress really didn’t say, “We deem the payment is made only on this one date and *don’t* deem it on other possible dates.”

Whew, I’m pretty exhausted after all of that. I will deem myself exhausted and take a break…