Will I qualify for a 1031 exchange?

[P. Kaye M.]

I have a SFR that I had rented from 2017-2020. It was rented for 3 1/2 years so I missed the opportunity to sell as my primary home. I haven’t had any rental income from it since 2021. I bought it sole owner in 2005 as a primary residence and converted it to a rental in 2017. I changed the ownership to joint tenancy with my husband in 2019. He passed away in 2022. I bought for 273K - retro appraisal for his date of death is 585K. I have done 20K in improvements + another 20K in improvements since this January to get it ready to sell. I have depreciated the house 30K during the 4 years of rental. In looking back at my tax records, I did not “abandon” the property, I just had no rent to claim the next years, in 2021 and forward. My husband and I were legally separated when I bought the home and had since reconciled and ended up with two houses. We were not allowed to file taxes jointly until we vacated the legal separation in 2021, which we did. So 2021 was the first year we jointly filed taxes and there was no rental income from either house. Will I qualify to do a 1031 since I wasn’t currently renting it out? Can the combination of rent and appreciation qualify it as being held for investment purposes or will IRS say I was not trying to rent it and deny 1031? I am intending to purchase a SFR in my town that is more suitable as a rental. I will reinvest all of the funds from the anticipated 600K sale (less 35K in selling costs).

I just listed the house for sale and expect it to sell soon.  I have identified a property I would like to buy. I have made an offer on the new property. I do not have a Q.I. yet. Any input on all of this? Appreciate this helpful forum!

[Bill Brandt]

1) talk to a tax pro but I THINK you inherited the value at the time of your husbands passing as your new cost basis. So after selling costs you may not have any/much taxable gain?

2) if you need a QI and you need an answer to this complex question reach out to @Dave Foster, he’s the go to expert in 1031’s. Heck, he probably won’t even have to look up the answer, he’ll just know. :-)

3) you’ll want to talk to a tax pro about if you should have or were required to keep taking depreciation after you stopped renting it out. Then you should have a pretty clear cut idea of what the 1031 will save you. Good luck. 

[P. Kaye M.]

Thanks, Bill

I have wondered if I should have kept taking depreciation. Unfortunately, I have been guessing about a lot of things I shouldn't have been guessing about!  I assumed I couldn't depreciate it because I didn't have any income. 

Concerning the stepped up value - I think the cost basis for 1/2 of the property is stepped up and the other 1/2 is my original cost basis. I am not sure how to appropriate the improvements done before and after both the reconciliation and the death of my husband.

[Dave Foster]

@P. Kaye M., If you end up having to recapture depreciation you'll either have to recapture all that you took - or all that you could have taken!!!  Not a nice trick from the IRS.  

[P. Kaye M.]

Hi, Dave

Could I have taken the depreciation during the last 3 years when I did not rent it? If so, I might do well to amend those tax returns and take the depreciation and expenses of maintenance and utiilities.