Can I exchange a real estate contract...?

Can I exchange my real estate contract in a 1031 exchange?

In hot real estate markets around the country, South Florida is one example, more and more buyers are investing in "pre-construction" contracts -- meaning the investor pays a deposit and signs a contract to purchase a property that is not yet erected. Often, the property will not be completed for several months, or even years. Since the property value keeps rising during the construction period, investors can often sell their contract on the property for a good profit before the property is completed, and without ever actually owning the property itself. Does this sale qualify for a 1031? Can you buy such a contract as 1031 property?

The answer is yes, but this kind of exchange comes with some risk. The majority of legal authorities say that yes, an option or agreement to buy real estate is real property interest, and therefore eligible in a 1031 exchange. But there isn't a lot of authority on this specific subject, and none of it is overwhelmingly conclusive. So it's not clear if IRS would or would not challenge this kind of exchange.

Aside from whether contracts qualify to begin with, remember that you still have to meet the same qualifications for a 1031 exchange as with any other real estate. And with option contracts there are some particular tricky issues to deal with, like:

When does the "transfer" of the property occur to start the exchange?
What is the value of the contract?
Was the contract "held for investment"?

As always, it is important to discuss these issues with an experienced and smart Qualified Intermediary well ahead of time if you intend to try this kind of exchange.

--The Experts