IRS Code §1031 clearly states that for a property to qualify as a tax deferred exchange during a transaction, it must be “held for investment.” There wide interpretation of the clause “held for investment” among tax professionals – the primary issue being the length of time a property is held to classify it as an investment. While the tax code doesn’t define a specific time after which relinquished property or replacement property will qualify as “held for investment,” a general consensus among many tax advisors is that a property should be held for a minimum of two years. Upon further examination, actual holding periods could be shorter depending on the right circumstances.
What truly matters is that the taxpayer’s intent at the time of the exchange is to hold the property for investment, not the length of time it is held. While this may seems to favor the taxpayer, the IRS requires additional objective data to valid the taxpayer’s claim that the property was intentionally held for investment or use in a trade or business. This includes the actual period of ownership, whether or not the taxpayer can demonstrate the property is being utilized for business or investment purpose, and the taxpayer maintaining a tax reporting history documenting the activity. Be advised, however, that a quick sale of the property within a short period following acquisition could be a red flag to the IRS indicating that the taxpayer’s intent in acquiring the property was to “flip” for a profit rather than hold for investment. In that case, the exchange transaction would likely fail to qualify for tax deferral.