1031 Exchange Q and A: Can Developers Use 1031 Exchanges?

Here is another in our series of 1031 exchange questions and answers. 

This Q and A concerns “dealer’s property” and whether a developer can use a 1031 exchange.

Simon is the owner of “Ace Estates,” a real estate development business in Irvine, California.  He buys undeveloped land, hires architects and contractors, builds houses on the land, and then sells them to the public.

Felix has asked Simon whether he would be willing to do a Section 1031 exchange of one of Simon’s new houses for some land that Felix owns near Seattle, Washington.

Simon wants to expand his development projects, and he thinks that property values are still positive in the Seattle area.  He thinks Felix’s proposal is a great way to get a start in Seattle, and also legally avoid paying capital gains taxes on his profit from the house that Felix wants.

Can Simon exchange the house in Irvine for the land in Seattle under Section 1031?

Unfortunately, Simon cannot use any of the houses built and developed by Ace Estates for a Section 1031 exchange, because the IRS considers such properties to be inventory, intended primarily for sale, not business use or investment (known as “dealer’s property”).

Under Section 1031, inventory, stock in trade, or any other property that is held primarily for sale rather than business use or investment (“dealer’s property”) is disqualified from tax-free exchange.

Property is considered inventory when it is held for sale to customers in the ordinary course of business. For example, if you own a business that sells airplanes, then you cannot use one of those airplanes as qualified property in a Section 1031 exchange.

The dealer property exclusion rule also means that real property held for sale by dealers in real estate does not qualify for Section 1031 exchanges. Here, Simon is a dealer in real estate (he sells houses that he builds) and therefore can not use a 1031 exchange to transfer his inventory.

From 1031 Exchanges Made Simple, available at Amazon.com. 

To contact Melissa J. Fox about serving as a qualified intermediary or for other 1031 exchange services, send an email to strategicfox@gmail.com

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