Exchanging Lots of Lots

IRC §1031 provides, in part, that property held for investment may be exchanged for like kind property to be held either for the productive use in a trade or business or for investment. The characteristics of land held for “investment” are:

 

·         The taxpayer acquired the land with the intent of holding the land PRIMARILY for long term growth and investment.

·         The taxpayer has other full time employment or is self employed in an unrelated business activity.

·         The taxpayer held the property for a period of more than one year.

·         The taxpayer was not personally involved in the sales efforts and spent most of his time and effort in other unrelated endeavors.

·         The taxpayer hired the services of an independent contractor who, for a fee, provided all of the marketing and selling effort.

·         Sales activity is random and unpredictable. Each contract is separately structured and negotiated and the sales possess no continuity or predictability. Offers are often received from unsolicited buyers. Sales occur over a substantial period of years.

·         The taxpayer had improvements made to the property solely for the purpose of making the whole of the property marketable and adding value. The cost of the improvements were small compared to the fair market value of the property and consisted of obtaining permits for future development.

·         The taxpayer capitalized holding and improvement costs and deducted expenses and interest only to the extent of investment income.

 

Let’s look at some examples of land held for investment which qualify for an exchange.

 

1.      An individual isolated lot, parcel or tract of land held by the taxpayer for investment for a period of more than one year qualifies under §1031 for non-recognition treatment if given or received in an exchange for other real property held either for investment or for the productive use in a trade or business.

2.      The land or lot adjacent to the taxpayers personal residence which has been held by the taxpayer for more than one year for the incremental increase in value and treated for tax purposes as land held for investment if exchanged for other real property to be held either for investment or for the productive use in a trade or business also qualifies for non recognition treatment under IRC §1031.

3.      The lot or lots in the subdivision of lots which have been held by the taxpayer for more than one year and which have been treated for tax purposes as land held for investment.

4.      The subdivided tract of land which has been held by the taxpayer for more than one year and is to be sold in a single transaction to the same buyer.

 

There are however, many situations where land or lots are not deemed to be real property held by the taxpayer for investment. Rather, the land held by the taxpayer is deemed to be held for personal use or for sale to customers in the ordinary course of a trade or business, “Dealer Property” The characteristics of land held as “Dealer” property are:

 

·         The taxpayer acquired the land with the intent of holding the property primarily for the resale in the ordinary course of a trade or business.

·         The taxpayer owns a land development and general contractor business and is involved in other similar projects.

·         The taxpayer held the property for a period of less than one year.

·         The taxpayer was personally involved in the efforts to sell the land on a continuous basis involving a substantial portion of his time over a protracted period.

·         The taxpayer personally participated in the sales activity by marketing, advertising, promoting sales, showing property to prospective buyers, soliciting offers, negotiating and structuring agreements and managing other sales agents and staff. The taxpayer conducts all sales in his office which is specifically set up to handle the sales activity.

·         The taxpayer commenced sales of the property immediately after acquisition. Sales occur on a regular basis with predictable frequency. Sales contracts are all similar and possess a substantial degree of continuity.

·         The taxpayer made improvements to the property to increase the value of partial and individual sales.

·         The taxpayer expensed all costs associated with the sales activity and the construction of improvements in the tax year the expenses occurred.

 

Let’s look at some examples of land or lots which are not held for investment and do not qualify under IRC §1031.

 

1.      Land or other property which is acquired and subsequently sold pursuant to a prearranged plan or property which is acquired subject to a lease and option to buy.

2.      The land or lots which are acquired with the intent to resell at a profit and which are sold within one year of acquisition.

3.      The land or lot adjacent to the taxpayers personal residence which is used primarily by the taxpayer for personal purposes and which the taxpayer declares an interest deduction on Schedule “A” Form 1040 as personal residence interest. In several cases, the IRS concluded that as much as 65 acres of land adjacent to a taxpayer’s residence was part of the taxpayer’s residence and qualified under IRC §1034 for the residence rollover provisions. It is therefore presumed that the land in the hands of the taxpayer would not have qualified for exchange treatment.

4.      Land or lots which are or will be dealer property in the hands of the taxpayer. The characterization of land or lots as dealer property involves an analysis of the extent to which the property is deemed to be held by the taxpayer primarily for sale to customers in the ordinary course of a trade or business. Dealer property does not qualify for exchange treatment under §1031.

 

The determination of whether property in the hands of a taxpayer is dealer property or property held for investment is often very subjective and incapable of external verification. Dealer property or not, is an opinion based upon many factors, the contributions of which may be weighted differently by the entity giving or making the opinion. Needless to say, if a taxpayer desires to treat land as non dealer property, property held for investment, the taxpayer should make every effort to avoid activity which is characteristic of dealer property.