two equal sized residental lots covering 3 acres of land, acquired 10 years ago, in one purchase transaction. Home constructed on lot # A.  Lot # B now proposed to be exchanged for similar value of developed residental lot(s).   Its a slam dunk that the residence and of course, Lot A underneath the home would not qualify as business or investment property eligible for 1031 treatment.  But, may Lot # B qualify for 1031 treatment?

Thank-you

It depends on how the property owner treated and reported the property (Lot B).  Did they treat and report it as investment property?  The important requirement is what their intent was and how they treated and reported the property.  They should have no problem qualifying for 1031 exchange treatment as long as their intent was to hold the Lot B for investment purposes and they also treated and reported it as such.

nope, only reporting would have been the mortgage interest.  One mortgage, all deducted as residential mortgage interest. Any chance to amended, say last couple of years returns to reclass pro-rata portion as investment interest, to help achieve desired end result?

Thank-you!

The critical issue involved here is they would need to prove under audit that they hand the intent to hold Lot B for investment.  The fact that they had one mortgage and reported it as mortgage interest as their primary residence would make proving their intent more difficult.  What was their intent for Lot B?  They may have had the intent to acquire the larger property and use Lot A as their primary residence and hold Lot B for investment but just did not report Lot B correctly.  They can go back and amend their income tax returns to reflect that Lot B was held for investment property and deduct the interest and property taxes, etc., as investment expenses.  They could report it as investment property for 2007 if they have not yet filed their 2007 income tax return.  The risk would be that they had already reported it as a personal residence and it is documented.