Gifted Property & 1031 Exchanges

gifted property 1031 exchange

Many people are unaware that you can conduct a 1031 exchange of property that you received as a gift. If you held the gifted property for a qualified purpose, which is for investment purposes or for use in your trade or business, then you should be able to defer the federal capital gains taxes.

In a 1031, both your old property (relinquished property) and your new like-kind property (replacement property) will qualify for 1031 exchange treatment if they are considered to be qualified use property.

Proving Your Intent to Hold for a Qualified Purpose

It is important that you intend to hold your properties for investment purposes in order to qualify for 1031 tax deferral. This means that your property involved in the exchange must be held for investment or used in your trade or business. If you used the property for personal use (such as your home) or held the property as inventory or stock in trade (i.e. they are held for sale), then they may not qualify for 1031 exchange.

A good way to prove that you have the proper intent to hold for a property for qualified purpose is to keep your properties for a substantial period of time, so that you can show you had the intent to hold for investment. During this holding period you can do things with your property that are consistent with investment or business. (i.e. renting them out for market rate lease). However, there is no mandatory minimum period of time that you must own property before conducting a 1031 exchange.

If you have a few years of tax returns showing that the property was held consistent with business or investment (i.e. showing rental income, deprecation or other business expenses) you will able to prove your case much better if you are ever audited.

Can I Gift My 1031 Replacement Property Away?

After you have completed a 1031 exchange and have your new like-kind replacement property, you may want to give it away as a gift. This is a huge trap for the unwary, because people think it is their property, and they should be able to do what ever they want with it.

Well, if they want to satisfy the requirements of their 1031 exchange, then they should probably not do anything (including gifting) that is inconsistent with holding the new replacement property for investment or use in their trade or business.

The argument can and has been made successfully by the IRS that if you gift the property away shortly after completing a 1031 tax deferred exchange, then you did not have the requisite intent. Your immediate intention to give away property you received in an exchange could undermine your ability to prove your investment or business intent.

Treasury Regulation 26 CFR 1.1002-1(b) and (c) indicates that the IRS can look at surrounding facts and circumstances such as post-exchange transfers of your replacement property as circumstantial evidence that you did not have the proper intent to hold for business or investment purposes.

A 1031 Gifting Example

In a U.S. Tax Court case entitled Click v. Commissioner, 78 T.C. 225 (1982), a taxpayer named Dollie Click exchanged with the Marriott Corp., a farm she had held for investment purposes, for two residential homes (plus some taxable boot in form of a note and cash). After the exchange was completed, Dollie Click allowed her children to live in the two homes for seven months rent-free. Her children took out property insurance on the homes and paid property taxes. Her children also made and paid for repairs and improvements to the homes.

After seven months, Dollie Click gifted the homes to her children. The U.S. Tax Court decided (which holding was affirmed by the Fourth Circuit Court of Appeals) that Dollie Click did not qualify for Section 1031 tax deferral on her (partial) exchange of the farm for the homes, because she did not intend for the homes to be held for investment or business use. It was determined that her activities were highly indicative of intent at the time of the exchange to make a gift the homes to her children.

When you conduct a 1031 exchange and receive your new like-kind replacement property, your main desire (at the time of completion of the exchange) should be to hold your like-kind replacement property for productive use in business or for investment.

  • 1031 Hotline: If you have questions about gifting property after a 1031 exchange, feel free to call me at 612-643-1031.

Defer the tax. Maximize your gain.

 

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