The Holding Requirement in Arkansas 1031 Exchanges
As we’ve been discussing on previous blog posts, IRC Section 1031 is among the most significant tax benefits for Arkansas taxpayers. Section 1031 allows Arkansas owners of investment or business real estate to defer capital gain taxes when they reinvest in like-kind real estate. The rules of Section 1031 are complex. When an Arkansas investment property owner wants to conduct an exchange, he or she needs to obtain the services of a facilitator (also known as a “qualified intermediary”). Arkansans need to be sure that their facilitator is sufficiently grounded in the rules of Section 1031, otherwise, their exchange could be jeopardized.
In this post, we’re going to discuss the ins and outs of the so-called “holding requirement” of Section 1031. In certain cases, there may be a legitimate dispute as to whether the holding requirement will be met. In those cases, Arkansans need to seek counsel from an experienced attorney.
The Holding Requirement is One of Four Elements of Section 1031
There are four elements of Section 1031. These elements (or requirements) emanate directly from the language of the tax code. The elements are eligibility, intent to hold, like-kind, and actual transfer. We can understand these elements more clearly be examining the body of case law which has developed in this area. So, for instance, we know that the “like-kind” requirement is interpreted broadly, so that virtually any parcel of real estate can be exchanged for another parcel, regardless of differences in grade or quality. Similarly, we can gather information about the contours of the holding requirement by examining case law.
The Holding Requirement is a Subjective Determination
The holding requirement can be stated in this way: to conduct an exchange, the owner must have an intent to hold the property for business or investment purposes. In other words, whether a property qualifies as a business or investment property depends on how the owner intended to use the property. In practice, this means that the holding requirement is a subjective determination. To establish intent, the court will examine the situation and take account of all relevant facts and circumstances. If the facts and circumstances of a given case point to the conclusion that the owner did intend to hold the property for business or investment, then the requirement may be met.
Many people incorrectly assume that the holding requirement is an objective determination. In this vein, those people often conclude that the requirement can be satisfied as long as the owner owns the property for a specific amount of time. Facilitators often counsel property owners to hold property for a minimum of 2 years, for instance. The problem with this is that holding requirement cannot be satisfied in this way. As mentioned, it is a subjective determination and requires a case-by-case analysis which involves weighing multiple factors.
Arkansas Real Estate Owners Should Seek Counsel
In the majority of cases, the issue of whether the holding requirement has been met is straightforward. Usually there is no question that the requirement has been fulfilled. In edge cases, however, things can be tricky. For instance, there can be a dispute about whether a “summer home” or vacation property qualifies as an investment property when an owner uses it as both a temporary personal residence and a rental property. In those cases, Arkansans should consult with an experienced attorney. The IRS publishes guides and other reference material which can be used to settle many potential disputes before they arise. An experienced attorney will be able to walk you through these kinds of issues.
Contact the Davidson Law Firm for Additional Resources
Arkansas owners of business or investment real estate should consider a 1031 exchange before they sell their property. Conducting a successful 1031 exchange can often lead to significant increases in earning potential. To learn more, contact the Davidson Law Firm by calling 501-374-9977. We can refer to a leading qualified intermediary in Arkansas, 1031 Exchanges Services, LLC.