Is a 1031 Exchange AND 121 Exclusion Possible?

Question

My wife and I bought a property 50/50 with my In-Laws. We bought it in September '13, knowing we would sell it to an interested home builder. The property sits on several acres.

I have read of scenarios where you can claim a percentage of the property as your primary residence to reap the benefit of the 121 exclusion ($500K Exemption), and the other percentage as investment property to earmark for 1031 exchange. This seems to work with farms and ranches.

My question would be, can my wife and I take residence in the house for two years to claim the 121 exclusion, and turn the remainder of the property into a working farm or ranch to claim it as investment property eligible for 1031 exchange?

It would pencil out like this:

Sales Price:             $3,600,000

Basis:                       $600,000

Net Gain:                 $3,000,000

Our Share (50%):   $1,500,000

121 Exemption:       $500,000

1031 Eligible:          $1,000,000

Primary Residence: 33.33%

$$ Producing Land:  66.66%

We now have the property under contract with a home builder. Escrow is 24 months to allow for completion of zone change as well all city approvals. This gives us just enough time to hit the 2 year rule for the 121 Exclusion.

Any thoughts??

Steven Hamilton II · Answer

@Bill Exeter ,

I find this one interesting.  The long time line of moving in and staying there. The big problem is joint ownership.

@Matt E,

This is correct.  If you bought and moved in. Held it for AT LEAST 24 months, I don't particularly see an issue. The downside I see is if you sell it right away.  Definitely no 1031 if you sell right away. If you hold it and sit on it for awhile i see it differently.

The problem I see is the contract that you have entered into.  That IS A HUGE problem.  Since you have already entered contract I would say no exclusion, no 1031.  Be happy you'll end up with long term capital gains.

-Steven

Bill Exeter · Answer

Hi Matt,

1031 Exchange

First, in order to qualify for 1031 Exchange treatment you must have the intent to hold the property for rental, investment or use in a business.  In your case, you acquired the property in 9/2013 with the intent to sell to a builder.  Your intent in this case was acquired and held for sale (not investment), and you would not likely qualify for 1031 Exchange treatment.  You also put the property under contract within a few months, which supports the position of held for sale versus held for investment.

121 Exclusion

You would probably not receive the full $500,000 exclusion.  You would first need to calculate exactly what percent of the property was your primary residence.  Advisors often use square footage or acreage to determine this.  Then, the total capital gain would be allocated based upon this percentage, and you can then exclude the amount allocated to your primary residence up to the $500,000 limitation.

Matt E. · Answer

Thank you very much for taking the time to analyze my situation. I appreciate your expert input.

Matt E. · Answer

Well that rains on my parade...

Matt E. · Answer

Also, I have heard this to work for owner occupied duplex/triplex/fourplex.

(Though not applicable to my case)