Section 1031 allows an investor to sell one business asset or investment, and then reinvest the proceeds from the sale of the asset in the purchase of a new asset of like-kind to defer capital gains taxes. One common question is whether a 1031 exchange can be executed on properties purchased with the intent of being fixed and resold, or ‘flipped.’
1031 specifies that the property must be held for use in a trade or business or for investment, and that the subsection shall not apply to property held primarily for sale. However the code fails to define the proper hold time to define held for investment vs. held for sale, creating a gray area where the rules and facts are not clear-cut.
The issue that comes up with flipping properties is typically the intent is to quickly fix the property then turn around and sell for a quick profit. The property in this instance is deemed to be inventory rather than an investment, and as such, the sale would not be eligible for 1031.
If the 1031 Exchange is selected for further review and audit, the courts will look to factors such as hold time of the property, intended and actual use of the property, amounts of prior sales, seller’s history and the nature of the individual’s business.
When deciding whether to utilize a 1031 exchange, all factors should be considered. The potential benefits should be weighed against the costs of an IRS audit, interest, and penalties that could be incurred.