12A — September 13 - 26, 2013 — Mid Atlantic Real Estate Journal
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F inancial D igest
By Pamela A. Michaels, Esq. and Scott Saunders, Asset Preservation, Inc. Substantiating intent in a § 1031 Exchange
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taxpayer’s intent to hold both the relin- quished property and
substantiating the investment intent is the responsibility of the taxpayer and the items be- low are not an exhaustive list but provide useful indicators in determining the taxpayer’s intent. • The purpose for which the property was initially ac- quired. • The purpose for which the property was subsequently held. • The purpose for which the property was being held at the time of sale. • The extent of advertising, promotion of other active efforts
used in soliciting buy- ers for the sale of the property. • The listing of property with brokers • The extent to which im- provements, if any, were made to the property. • The frequency, number and continuity of sales .• The extent and nature of the transaction. • The ordinary course of busi- ness of the taxpayer. Real estate held as “stock in trade or other property primarily for sale” is excluded from the tax deferral benefits of IRC Section 1031. Stock in
trade describes property which is included in the inventory of a dealer and is held for sale to customers in the ordinary course of business. The gain on the sale of this property is taxed as ordinary income. A 2010 Tax Court case il- lustrates the consequences of failing to substantiate invest- ment intent. In Goolsby v. Commissioner (April 1, 2010); T.C. Memo. 2010-64, taxpay- ers exchanged a relinquished property in California for two replacement properties located in Georgia. Two months after the exchange was completed, the taxpayers moved into one of the replacement properties (the Pebble Beach property) and used it as their personal residence. The IRS took the position that the Pebble Beach residence was not acquired with the requisite intent to hold for investment and failed to qualify as replacement property within the meaning of Section 1031(a). The Tax Court rejected the taxpayers’ argument that cer- tain other facts demonstrated that they intended to rent the property when they acquired it and decided later to move into the property. As a result, the taxpayers were liable for the capital gain taxes allocable to that portion of their exchange and also for an accuracy related penalty for understatement of tax. In rejecting the taxpayers’ argument, the Tax Court found that the Goolsbys: -conditioned the purchase of the Pebble Beach property on the sale of their former primary residence in California; -asked their qualified inter- mediary (QI) about converting an investment property into a residence before the exchange was completed; -failed to research whether the covenants of the homeown- er’s association would permit the Pebble Beach property to be used as a rental and generally did little research on the rental market; -placed a rental advertise- ment in a small neighborhood newspaper for only two months and made no other efforts to rent the property; -began preparations to fin- ish the basement of the Pebble Beach property within two weeks after purchasing the property. Note that any non-privileged discussions evidencing a con- trary intent before, during, continued on next page
transaction to determine the taxpayer’s true intent at the time of the exchange. If those
replacement property for investment or for use in a trade or busi- ness is a re- quirement for any exchange transaction qualifying for
facts and cir- cumstances are not con- sistent with the requisite intent, the ex- change may not qualify for tax defer- ral.
Pamela Michaels
Scott Saunders
tax deferral under Internal Revenue Code Section 1031. The IRS and federal courts may examine all of the facts and circumstances surrounding the
Listed below are some fac- tors the IRS may review to determine whether or not the intent was to hold the property for investment. The burden of
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