Part 1 of this article appeared in the April 17th edition of the New York Real Estate Journal.
In addition, regardless of establishing that a property may be qualifying real property, certain types of property will never qualify due to the fact that they do not constitute real property interests. These interests include partnership interests, membership interests in an LLC and shareholder interests in a corporation. These interests are generally considered personal property except in very limited instances such as when the entity is disregarded for federal tax purposes. In general, the entity- partnership, LLC or corporation who owns the property is the tax owner of the real property not the investors who own interests in such entity which are personal property interests. Investors seeking to perform a §1031 exchange on the sale of assets owned by such entities must ensure that either the exchange is to be performed at the entity level or that they have obtained tax advice in advance of marketing the property for sale to determine what steps should be taken to enable the investors to independently perform §1031 exchanges at the investor level and what risks may be involved in doing so.
Finally as indicated above, both what is being sold and what is being purchased must qualify as being held for investment or productive use in a trade or business. Purchasing residential replacement property and using it as a primary residence or exclusively for personal enjoyment will generally disqualify an exchange unless there are clear facts to substantiate that it was the investor’s intent to hold the property for investment when the property was acquired.
A case in fact demonstrating the above is Goolsby v. Commissioner, (April 1, 2010); T.C. Memo 2010-64. Therein the court found that the purchasers intended to use the property as a primary residence from the day of acquisition and there was never the intent to hold for investment.
In contrast,in a later tax court case, Reesink v. Commissioner, (April 23, 2012) T.C. Memo 2012-118, a residential property was purchased and converted to a primary residence eight months thereafter. Notwithstanding, the tax court found that the Reesinks intended to hold the rental property as an investment at the time they engaged in the 1031 exchange and noted the following:
• The Reesinks placed many rental flyers throughout the town advertising the house as available for rent;
• The Reesinks showed the house to two different potential tenants;
• The taxpayers refrained from using the property for recreational use prior to moving into the property;
• The Reesinks decided to sell their personal residence almost six months after purchasing the replacement property; and
• The Reesinks waited over eightmonths after acquiring the property to move in.
Every taxpayer should make significant and meaningful efforts to treat a replacement property acquired in a §1031 exchange as a qualifying property held for investment for a significant time period before converting this property into a residence or any other non-qualifying use. The IRS and Tax Courts will look at all of the objective facts and circumstances regarding an exchange transaction to ascertain the taxpayer’s subjective intent at the time of the exchange.
Pamela Michaels, Esq., is sr. vice president with Asset Preservation, Inc., New York, N.Y.
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