So — you’ve decided to seize the opportunity and enjoy the benefits of a 1031 exchange! Or maybe you’re still gathering information before making that leap. After all, why wouldn’t you take advantage of a tax break that lets you defer capital gains taxes, potentially into perpetuity?
While 1031 exchanges are a great way to keep money in your pocket — legally — and out of the IRS’s grip, like any tax break they come with important stipulations to which you must adhere to ensure you can actually use them.
One such requirement to which all 1031 exchanges must adhere is what is known as the 1031 exchange holding period. Luckily for you, we’ve got the 411 on what you need to know about this little wrinkle in the 1031 exchange process. Keep reading to learn more about 1031 exchange benefits, the ins and outs of the 1031 exchange holding period, and how to make the most of this powerful tax strategy.
Understanding 1031 Exchanges
Perhaps you’re already familiar with the basic function of a 1031 exchange, but for the uninitiated or less familiar, we’ll lay out a basic understanding. A 1031 exchange, named for Section 1031 of the Internal Revenue Code, describes a specific series of transactions that basically results in a tax break when you sell your rental property. It enables you to defer the capital gains taxes you would normally owe the IRS from the sale of an investment property.
Instead of paying Uncle Sam 15-25% of the sale proceeds, you can “exchange” the original property for another “like-kind” property, hence the name. To be considered a like-kind property, the new property must be of equal or greater value and also be used for investment purposes.
So, while you can’t swap out your apartment building for a fancy new pad for yourself, you can avoid paying taxes on the sale of the property by upgrading to a more lucrative investment property.
The sweetest part of a 1031 exchange is that you can swap out investment properties indefinitely, so long as the rules of a 1031 exchange are closely followed. That means you can continually upgrade the properties you manage without paying taxes from their sales.
One of the rules that investors must follow when executing a 1031 exchange is the 1031 exchange holding period.
What is the 1031 Exchange Holding Period?
One of the most common concerns with 1031 exchanges is determining how long the owner must hold on to a property before it can be exchanged for another property. This is often referred to as the 1031 exchange holding period.
Figuring out the exact timeframe for this holding period is a bit tricky, as the IRS does not explicitly state how long you must hold a property before you can sell it in exchange for another. However, there are some precedents that lend a bit of insight into what the IRS likes to see from investors who wish to exchange properties for this tax break.
One key thing the IRS wants to see is that the investment property is being held for “productive use in a trade or for business or for investment.” This means you can’t simply acquire a random property to defer taxes and then sell that property — you actually have to use it for your own business or investment advantage.
While the IRS has not stated a specific amount of time that defines this holding period, many CPAs, tax experts, and legal advisors generally agree upon a minimum 1-2 year window for holding property. This guidance is based on past proposals from Congress for a 12-month holding period, although the proposal was never codified. In addition, because the property will show up on your annual tax returns, holding it for 1-2 years helps establish good faith with the IRS for a successful future exchange.
To help you understand, I’ll provide a couple of examples that illustrate why this holding period matters.
The 1031 exchange holding period is crucial for a successful 1031 exchange. However, due to the ambiguous nature of the guidance surrounding it, investors should not attempt 1031 exchanges on their own and should seek professional advice to ensure they don’t find themselves disqualified from a 1031 exchange in the middle of the process.
Let Canyon View Capital Experts Help With Your 1031 Exchange
For property investors, 1031 exchanges can be an excellent way to sell properties and defer capital gains taxes into perpetuity. However, investors must abide by many prerequisites and rules, like the 1031 exchange holding period, to execute this transaction successfully.
For 40+ years, CVC professionals have managed, owned, and operated various types of real estate. Now, we co-own and manage a portfolio of multifamily properties valued at over $1 billion1. That’s why we understand the benefits and nuances of 1031 exchanges better than most, and we work closely with our investors to guide them carefully through this complicated process to completion.
Completing a 1031 exchange often means helming murky waters, which makes it easy to get lost along the way. With CVC experts at your side, you’ll have a reliable navigator to lend clarity on 1031 exchanges, along with a full crew of experts who can offer advice on taxes, accounting, and any other lingering financial concerns so you become a more seasoned investor.
Still hazy on the details of a 1031 Exchange Holding Period?
Canyon View Capital can show you the way! We will walk you through every step of your 1031 exchange, and our in-house professionals will always answer your questions honestly, completely, and promptly. CVC will help you cut through the red tape, no matter how sticky it gets. Contact Canyon View Capital.
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Gary Rauscher, President
When Gary joined CVC in 2007, he brought more than a decade of in-depth accounting and tax experience, first as a CPA, and later as the CFO for a venture capital fund. As President, Gary manages all property refinances, acquisitions, and dispositions. He works directly with banks, brokers, attorneys, and lenders to ensure a successful close for each CVC property. His knowledge of our funds’ complexity makes him a respected executive sounding board and an invaluable financial advisor.