In order to complete a tax-free exchange under IRC Section 1031, a taxpayer must exchange property that is either used in a trade or business, or held for investment for other property of a like-kind that is also either used in a trade or business, or held for investment. An exchange does not qualify for Section 1031 treatment if either the relinquished property or the replacement property is a personal-use asset.

In Patrick A. Reesink, T.C. Memo 2012-118 (April 26, 2012), the taxpayer sold his interest in an apartment building and purchased a single-family home (Laurel Lane) as a replacement property. The purchase closed on November 4, 2005, and the taxpayer posted flyers locally, listing the home for rent. The taxpayer had listed the property as investment property on the application he completed in connection with the purchase. Potential renters looked at the property but none ever rented it. In May 2006, the petitioner sold the home he was then occupying as a residence because of mounting financial pressures. In June, he and his wife moved into Laurel Lane.

The IRS took the position that Laurel Lane was not held for investment by the taxpayer because he never actually rented it and occupied it as his residence within eight months after purchasing it. The court nevertheless found in favor of the taxpayer, pointing out that his intent at the time of the exchange is determinative. The court found that the taxpayer did enough to demonstrate his intent to rent the property by posting rental flyers and showing it to prospective tenants. The fact that he occupied the property as his residence fairly soon after its purchase was attributable to a change of circumstances and did not mean that the taxpayer did not intend for the home to be a rental property at the time of its purchase.

While the taxpayer’s actions in this case do not translate into a paradigm of good, conservative tax planning, the case does point out that the bar is not very high to establish the taxpayer’s intent that a property be considered “held for investment” following an exchange.