The “Held For” Requirement for 1031 Property Received or Exchanged

In order to qualify for a 1031 Exchange, the Relinquished and the Replacement Properties must both have been acquired and “held for” investment or for use in a trade or business. The amount of time that the property must be “held for” use in a trade or business is not specified in either the Code or the Regulations.

The position of the IRS has been that if a taxpayer’s property was acquired immediately before an exchange, or if the Replacement Property is disposed of immediately after an exchange, it was not held for the required purpose and the “held for” requirement was not met.

There is no safe harbor holding period for complying with the “held for” requirement. The IRS interprets compliance based on their view of the taxpayer’s intent. Intent is demonstrated by facts and circumstances surrounding the taxpayer’s acquisition of ownership of the property and what the taxpayer does with the property. The courts have been more liberal than the IRS on these issues.

Here are some examples of transactions that should be considered to have potential for a finding by the IRS that the “held for” requirement has not been met:

• The taxpayer acquires Replacement Property and immediately lists the property for sale. The IRS will interpret the intent to acquire the property for resale instead of for investment purposes.
• The taxpayer receives the Relinquished Property by deed from a partnership and immediately proceeds to sell/exchange it (aka “drop and swap”).
• The taxpayer acquires Replacement Property and immediately converts the property to a personal residence.
• The taxpayer acquires Replacement Property and immediately transfers the property to a corporation, partnership or LLC.

A cushion of time between events such as these is desirable to reduce the risk of possible “held for” issues in an exchange. Exchange Professionals recommend one year for the Replacement Property. The IRS has ruled that two years was adequate in a private letter ruling (Ltr Rul 8429039) but this was not made mandatory. In any event, the burden is on the taxpayer to support compliance with the “held for productive use in investment or a trade or business” requirement.