1031 property received will be sold in less than a year

Technical topics regarding tax preparation.
#1
El1  
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A client is a RE developer. He did a 1031 exchange in 2021 and acquired a property with intent to redevelop it.
The city now requires certain specs and low income units for the new development which will put the taxpayer in a loss. He wasn't aware of this when the property was acquired and wants to sell it in 2022, less than a year after he received it in the exchange. It will be sold at a loss from the purchase price, but the deferred gain from the 1031 will be released.
The general rule is to hold the acquired property for at least a year to demonstrate intent of the the property being for investment/business and not a flip, but I'm not aware of any regs that require a minimum holding period.
I suppose this will be a red flag for an audit, but was wondering if anyone else had a similar situation.
What documents would be needed in audit to demonstrate the intent and make sure the original exchange is not disqualified?
 

#2
MilesR  
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My question first is did this developer acquire the property in order to hold it for investment or to redevelop and resale? Is this property actually inventory? Did it qualify for 1031 in the first place?
 

#3
JR1  
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Exactly what I wondered, Miles.
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#4
El1  
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MilesR wrote:My question first is did this developer acquire the property in order to hold it for investment or to redevelop and resale? Is this property actually inventory? Did it qualify for 1031 in the first place?


There's no clear line between a dealer and an investor.
The client and his prior account took a position that he is an investor and not a dealer based on facts and circumstances. For the property in question we also took a position that this was an investment property and not inventory sold by a dealer.

The IRS may potentially raise this issue which will open up a can, but for now the concern is the investment property received in an exchange being sold in less than year.
I wonder if there are some specific steps or documents needed to demonstrate intent, so the exchange is not disallowed (assuming this an investment property)
 

#5
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You can sell a 1031 exchange at any time, there is no restriction. The restriction is on converting it to personal use.
 

#6
MilesR  
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For the question at hand, you would likely need to show proof that he really intended to develop it: business plan, consulting records, bids for contract work, tried to get permits and failed... something that shows he had some intent to develop it. Then show that he tried and failed to receive permitting, etc. An auditor might ask why he did not know this before he purchased it. Which is a valid question because if he had an intent to develop it, you'd expect that he would have researched and taken steps on how to do so before investing in it.

If there was rent on the property during 2021 and rent during 2022, then he could probably qualify for the safe harbor of showing at least 15 days of rent in at least each of 2 tax years. Also, courts typically say 366 days of holding is good enough in most cases so if he can wait to sell after holding it for that long, that should make it pretty safe.
 

#7
El1  
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MilesR wrote:For the question at hand, you would likely need to show proof that he really intended to develop it: business plan, consulting records, bids for contract work, tried to get permits and failed... something that shows he had some intent to develop it. Then show that he tried and failed to receive permitting, etc. An auditor might ask why he did not know this before he purchased it. Which is a valid question because if he had an intent to develop it, you'd expect that he would have researched and taken steps on how to do so before investing in it.

If there was rent on the property during 2021 and rent during 2022, then he could probably qualify for the safe harbor of showing at least 15 days of rent in at least each of 2 tax years. Also, courts typically say 366 days of holding is good enough in most cases so if he can wait to sell after holding it for that long, that should make it pretty safe.


Thank you
 

#8
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FWIW. I don't see this as a problem. Safe harbors are irrelevant if you don't meet the requirements. You certainly have a solid reason to report as a 1031. And it's a waste of time to worry about how to handle an audit before the audit notice is received unless you have some reason to feel the need to preserve evidence.
Steve
 

#9
El1  
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gatortaxguy wrote:FWIW. I don't see this as a problem. Safe harbors are irrelevant if you don't meet the requirements. You certainly have a solid reason to report as a 1031. And it's a waste of time to worry about how to handle an audit before the audit notice is received unless you have some reason to feel the need to preserve evidence.


Thanks for your reply. The FTB here in California placed 1031 exchanges as a top audit issue a few years back and were relentless in auditing them. It seems to change recently and not as many are audited now, but they still look at a fair amount of them.
 


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