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1031 HOLDING PERIOD 

Yes, there is a statutory Holding Period requirement for Section 1031 property.

In fact, there are two.

And they are different.

 

RELINQUISHED PROPERTY HOLDING PERIOD

Section 1031 does not identify a specific number of months that the taxpayer must hold the investment property before it can be sold and used as the Relinquished Property in a Section 1031 Like Kind Exchange.

But there are actually two statutory Holding Period requirements, and the first one is found in the definition of the law.

Section 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 if such property is exchanged solely for property of like kind which is to be held either for productive use in a trade or business or for investment. (Emphasis added).

In order for property to be “held for productive use in a trade or business” there must necessarily be a period of time that the property is being held.

This is the Holding Period.

Therefore, there is an impled statutory Holding Period for Relinquished Property in the language of the Section 1031 Exchange statute.

The second statutory Holding Period requirement for Relinquished Property is contained in the reason for Section 1031 existing in the first place.

The statute was not created so that the taxpayer could avoid paying taxes on Short Term Capital Gains.

Section 1031 was created as an incentive for taxpayers holding long term investments to sell those properties and defer the taxes by putting the proceeds into more investment properties.

The Holding Period for Long Term Capital Gains is at least one year and a day.

Section 1031 allows the taxpayer to sell investment property subject to Long Term Capital Gains taxes and defer these taxes to some point in the future by using all of the Net Sales Proceeds to purchase another investment property of equal or greater value.

That means that the taxpayer is putting off paying as much as 20% Capital Gains taxes today, in return for paying as much as 20% Capital Gains taxes sometimes in the future.

If Section 1031 were allowing the sale of investment property held for less than a year and a day, it would be allowing a taxpayer to put off paying as much as 39.6% Ordinary Income taxes, in return for paying as much as 20% Capital Gains taxes sometimes in the future.

This is not the original purpose of Section 1031 and it still is not the purpose of Section 1031.

The IRS never allows a taxpayer to use the Tax Code to move from a higher tax situation to a lower tax situation.

So, there is a statutory Holding Period for Section 1031 Relinquished Property, and that statutory Holding Period is at least one year and a day.

REPLACEMENT PROPERTY HOLDING PERIOD

As in the case of Relinquished Property, Section 1031 also does not identify a specific number of months that the taxpayer/Exchangor must hold the Replacement Property received in a Section 1031 Like Kind Exchange before it can be sold.

But there are also two Holding Period requirements regarding Replacement Property, and they too are different.

Section 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 if such property is exchanged solely for property of like kind which is to be held either for productive use in a trade or business or for investment.  (Emphasis added).

In order for a property “to be held either for productive use in a trade or business” there must necessarily be a period of time that the property is being held.

This is the Holding Period.

Therefore, like the Relinquished Property, there is an implied statutory Holding Period requirement for Replacement Property in the language of the Section 1031 Exchange statute.

The second statutory Holding Period requirement for Replacement Property is similar to the same requirement for Relinquished Property.

When you defer the taxes on your Capital Gains and Depreciation Recapture by investing the Net Sales Proceeds in a Replacement Property, you are then placed under two obligations.

1.)  You must have the intent (“property of like kind which is to be held”) of holding the property “either for productive use in a trade or business or for investment.”

2.)  You must then actually hold the property “for productive use in a trade or business or for investment.”

The length of “holding” that is required is the necessary time of “use in a trade or business or for investment” that satisfies the IRS.

Here’s the IRS position on that.

The asset we are talking about is a Section 1250 asset, rental real estate.

The sale of such assets is governed by Section 1231, and IRS Publication 544, entitled “Sales and Other Disposition of Assets,” says:

Section 1231 transactions are sales and exchanges of property held longer than 1 year and either used in a trade or business or held for the production of rents or royalties.

It is clear from this that the Holding Period requirement for Replacement Property is at least one year and a day, in other words, the period required for qualifying a sale for Long Term Capital Gains tax treatment.

This also conforms to the basic IRS policy that if one tax is being replaced by another tax, they must be the same level of taxation.  If the tax to be paid in the future is Long Term Capital Gains tax, then the tax being deferred currently must also be Long Term Capital Gains tax.

CONCLUSION

While there is no shortage of misinformation on the web, you should be very careful about taking any action regarding a Section 1031 Exchange until you have a talk with your Attorney.

Remember, this is between you and the IRS.

The salesman whose advice you are taking will not be sitting next to you at the table during the audit.

In fact, he will probably be providing the IRS with their information and documentation being used against you.

And by the way, he’s not supposed to be giving you legal advice anyway; he’s supposed to be an independent third party.