If you conduct a 1031 exchange, all property involved needs to be used for investment or business purposes. You can’t exchange into a replacement property and then immediately move into that property as your personal residence. But how long do you need to use the replacement property for investment purposes? In this article, we are going to discuss how long you need to rent your property out before you can qualify it for 1031 exchange.
The Longer the Better
The longer that you rent the property the better you may be able to substantiate/prove that you purchased the replacement property with the requisite intent to use in a trade or business or for investment. Two full years is a good general rule of thumb, but check with you own CPA or tax accountant because your specific situation and circumstances may impact this. A real market-rate lease with real rental payments from a third-party would be consistent with holding for rental purposes. Both properties in a 1031 exchange must be held for use in a trade or business or for investment, and it is your responsibility to prove that to the IRS if you are audited.
Personal Use vs. Investment Use
Property used primarily for personal use, like a primary residence or a second home or vacation home, does not qualify for like-kind exchange treatment. If you lease the replacement property and your CPA or tax accountant reports the ownership/income and expenses on your tax returns consistent with that rental business use, then you should be in a good position to substantiate/prove your tax-return position. An under-market lease to a related party wherein the lease payments do not bear some relationship to fair rental value may cause the IRS or a state taxing authority to question if the lease is a sham, so check with you own CPA or tax accountant about this.
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At Commercial Partners Title, we are known as experts in commercial transactions in Minnesota and across the country. Our team of commercial title underwriters, closers, and real estate attorneys can help guide you through each and every step of your commercial transaction and ensure that you are fully prepared when it comes time to close. Give us a call today at our downtown Minneapolis office to get to know us better and start working on your commercial transaction.