Attorneys at Law

Blog

HOLD ON THERE! DON’T FORGET THE HIDDEN HOLDING REQUIREMENT

A 1031 exchange affords taxpayers a significant benefit by deferring the payment of taxes normally payable upon the sale of property when that property is effectively exchanged for property of the same kind that is held for productive use in a trade or business or for investment.  Section 1031 of the Internal Revenue Code, which  provides for the exchange, afford taxpayers considerable latitude by not defining the term “property” and by using it rather expansively.  . Although real estate is frequently the property exchanged in 1031 exchanges, no such limitation is found in the statute and there is no reason to limit the use of 1031 exchanges to transactions involving real estate.    In fact, a wide variety of types of property can be exchanged, from real property to computers, automobiles, airplanes, licenses and copyrights.  .

While Section 1031 permits considerable latitude in the types of property that may be exchanged, the ability of a taxpayer to execute 1031 exchanges is constrained by what is known as the holding requirement.  Section 1031 of the federal tax code provides that “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.” 26 U.S.C. §1031(a)(1). The  property involved in an exchange must have been or must be “held for productive use in a trade or business or for investment.” 26 U.S.C. §1031(a)(1). Thus, both the property being relinquished and the property being received must meet the holding requirement. Ibid.

  Nothing, however, in either Section 1031 or its regulations specify a period of time that will meet the holding requirement.  One commentary suggests that property be held for at least two taxable years before a 1031 exchange is attempted. Stefan F. Tucker and Tammara F. Langlieb, “Understanding Like Kind Exchanges (With Checklist),” The Practical Tax Lawyer, vol. 26, no. 4, p. 21, 25. The general trend among analysts appears to be that property held for less than a year will likely be viewed by the IRS as not having met the holding requirement, and property held for two years or more likely will be viewed as meeting the holding requirement. Less clear is the fate of property held for between one and two years. Tucker and Langlieb’s comment, quoted above, seems to suggest that property held for less than two years but over at least two tax years (and appearing on two consecutive tax returns) is more likely to be viewed as meeting the holding requirement.

A taxpayer considering a 1031 exchange should insure that exchange property is held for business or investment use and should carefully consider whether a contemplated exchange meets the holding requirement.

Robert ElamComment