NEW GUIDANCE ON "HOLD FOR INVESTMENT" AND THE CONVERSION OF EXCHANGE PROPERTY INTO PRINCIPAL RESIDENCE
So you exchanged
into that bright, shiny new rental property and now things have changed. For
some reason, perhaps many reasons, you want to move into the new property
instead of renting it. What effect, if any, will that have on your exchange?
Recently the U.S. Tax Court ruled in
favor of a couple who moved into a property they acquired in an exchange eight
months earlier. The couple overcame an IRS challenge to their exchange, and the
facts and circumstances of their story can be helpful to us all. The case
summary below was provided by the Federation of Exchange Accommodators, our
national association, with minor editing and modifications. Please see our
comments about this case below the italicized text.
In Reesink vs. C.I.R., T.C. Memo 2012-118,
No. 2475-10 (April 23, 2012)
, the U.S. Tax
Court considered whether a single-family house was acquired by the taxpayers as
a personal residence or as an investment.
The facts of the
case: In 2005, the taxpayers sold a San Francisco apartment building, entered
into an exchange, and acquired a single-family house and a vacant lot in
Guerneville, CA. The taxpayers' mortgage loan application indicated that
the property was purchased as an investment. "For Rent" signs
were posted on the property. Flyers were distributed
Guerneville advertising the property for rent. Two prospective tenants
examined the property to consider leasing it, but each decided that they could
not afford the asking price of $3,000 per month. The taxpayers never
lowered their asking price. The property was never advertised for rent in
any local newspaper. The court did not say if the property was ever
listed for rent with a real estate broker, although the taxpayers consulted
After failing to
rent the Guerneville property for some time, Mr. Reesink wanted sell their San
Francisco home because they could not afford the carrying costs of all the real
estate that they owned. Mrs. Reesink resisted this idea because she liked
living in San Francisco and because she did not want to take their son out of
his current high school. Nevertheless, the parties listed their home in
San Francisco in April, 2006, about six months after they acquired the Guerneville
property. At that time, the Reesinks considered either moving to
Guerneville or moving in with Mr. Reesink's sister. Two months later,
when their San Francisco home was sold, they elected to move to
Guerneville. That was almost eight months after they acquired the
Guerneville property. Until they moved in, they had never stayed in the
Guerneville property or used it for any personal purpose.
Based on this
information, the IRS threw out their exchange based on the concept that the
Reesinks had not acquir
ed the Guerneville property for investment purposes.
However, the Tax Court ruled in favor of the Reesinks, finding that the
principal intention of the taxpayers in acquiring the Guerneville property was
for investment, not personal use. The court stated that perhaps the
strongest evidence of the Reesinks' investment intent came from Mr. Reesink's
estranged brother, who was actually a witness for the IRS, testifying that Mr.
Reesink told him on several occasions that they planned to move to the Guerneville
property after their son graduated from high school. That would have been
significantly more than two years after they acquired the Guerneville
property. This testimony gave weight to the position of the taxpayers
that they had changed their minds because of financial difficulties when they
decided to move to Guerneville in 2006.
concluding that the taxpayers had satisfied their burden of proving that they
held the Guerneville property principally for investment, the court
distinguished this case from an earlier one, Goolsby v. Commissioner, T.C.
Memo. 2010-64. In Goolsby, the Tax Court found that the taxpayers did not
have a bona fide investment intention when they acquired replacement property.
The court in Reesink pointed out that in Goolsby, the taxpayers:
made the purchase
of the replacement property contingent on the sale of their home
concerning when they could move into the replacement property
placed only one
advertisement in a local newspaper
the basement of the replacement property within two weeks of acquiring it, and
moved into the
replacement property within two months of acquiring it.
between Goolsby and Reesink begin to mark a line describing the burden of proof
that taxpayers will be expected to meet if they move into residential
replacement property before the end of the two-year safe harbor holding period
provided by Rev. Proc. 2008-16.
The "Bottom Line"
often asked how long a property must be held before it can be sold and used in
an exchange. We respond by citing the fact that there is no specified time period
in the code and it depends upon the intention for the acquisition. As an
exchange intermediary, we cannot interpret the regulations for an individual
taxpayer, but we can tell the taxpayer what the regulations say. We have always
stressed that intent is more critical than length of ownership. The case above
points out how important documentation of intent can be. The Reesinks might
well have lost their appeal had they not been able to establish and document
the actions they took prior to moving into the property. Here are some things
to consider in regards to documenting the facts:
If there is a loan on the new property,
is it a "second home loan" or an investment property loan?
What type of insurance policy is on the
property? Is it "Residence" or "Rental" coverage?
Has the property been offered for rent
at a fair market rate?
How and where has the property been
Have you or a family member used the
property for personal use? (Don't forget, the IRS can subpoena utility
records, credit card records, etc.)
What circumstances that led to the
decision to move into the property? Be sure to document them, perhaps in a
contemporaneous memo to the house file or in a letter to your tax preparer.
How much time has passed between the
acquisition of the replacement property and the conversion to a
residence? While not the determining factor, it is clear that the
more time has passed, the better.
speaking engagements, a theoretical example I often use is the landlord who
buys a house with the intention of renting it. He advertises it and signs a
one-year lease with a couple. Three months later, the couple wins the lottery.
They've lived there long enough to know it will be a fine home for them and
they make the landlord an offer to buy the house for $25,000 more than he paid
four months earlier. Based on intent, I would argue that the property could be
exchanged. (I would also strongly advise the landlord to discuss the matter
with his tax advisor before moving ahead!) If the landlord does enter into an
exchange, will it survive IRS scrutiny? Of course, no one can answer that
today. Clearly, though, the more the facts can be documented, the stronger the
case would be for the landlord.
We always recommend
that you discuss your transaction with your tax and/or legal advisor to
determine the best way to proceed in your particular situation.
If you are selling
your property and would like to discuss the pros and cons of a Section 1031
tax-deferred exchange, please contact Iowa Equity Exchange.