VA Househack 1031 Exchange w/ 121 Exemption

[Steven Embree II]

Here’s the skinny:

I am a veteran with a VA loan for a fourplex in which I reside in one of the units. I have lived here for three years, meeting the 2/5 year requirement for Section 121 Exemption. I am considering the sale of the property to partially fund the purchase of another fourplex (like kind).

There seems to be confusion with my lender on the following points:

1. I live on the property, so a 1031 Exchange may not apply. (I am not sure why it wouldn’t apply to the 75% of the property that is being used as investment property.)

2. The other units are investment property, so it wouldn’t qualify for Section 121 Exemption as that is only for a primary residence. (I am not sure why the 121 Exemption wouldn’t apply to the 25% of the property I live in.)

3. Moving away from the property may be an issue because, according to an underwriter, the VA requires primary residency for the property. (My understanding is that the VA only requires the property to be my primary residence for a year. I have been here three years.)

Am I in a no-man’s land where the tax gods can come and take money or is there some kind of special lamb’s blood I can paint over the four doors to get the IRS to pass by?

[Jeff Nash]

For tax purposes, you can handle the situation using a combination of 1031 and 121 as described.  @Whitney Nash can go into more depth and address the specifics of the 1031 rules.

[Dylan Speer]

1. 1031: Since you reside in one of the units, that unit is not considered investment property and may not qualify for a 1031 Exchange. You may be able to do a partial exchange for the other units that are investment property, but it's important to speak with a tax professional or real estate attorney to determine if this is feasible in your situation.
2. Section 121 Exemption: This exemption allows you to exclude up to $250,000 ($500,000 for married couples filing jointly) of capital gains on the sale of your primary residence, provided you have lived in the home for at least two out of the past five years. Since you live in one unit of the fourplex, you may be able to claim the exemption for that unit, but not for the other units that are investment property.
3. VA loan and primary residency: As a veteran with a VA loan, you were required to occupy the property as your primary residence for at least one year. Since you have lived in the property for three years, you have met this requirement. However, if you sell the property and no longer occupy it as your primary residence, you may run into issues with the VA loan. You should speak with your lender to determine what the consequences would be if you sell the property and move out.

Thank you for your service.

[Ran Iarovich]

love the metaphor at the end. Shop around different lenders and see how they can help you. One lender will not know it all - you need someone who has experience in the field and remember you are interviewing them not the other way around! Consider also getting an agent who has experience in the past helping VA investors. Once you have your dream team together things should run more smoothly.

[Whitney Nash]

Hello @Steven Embree II

As far as doing a 1031 exchange goes, you and @Jeff Nash are correct in that the 25% used as your primary residence would qualify for the 121 exclusion and you can take that gain, up to the limit, tax fee to use for anything you want. The other 75% of the property would qualify for a 1031 exchange. You and your tax preparer would need to determine the amount attributable to the primary residence and the rest would be used in the exchange. As far as the VA loan on the current property goes and the possibility of being penalized for that, I'm not sure. I would get a second opinion from another lender or expert in that field. If you are worried about getting a VA loan for your next property and they require primary residence use only, then you may want to use the 25% of gain attributable to your current primary residence towards the purchase of your next primary residence. Then, use the 75% in the 1031 exchange towards a different property that will be held for investment and satisfy the 1031 rules for reinvestment.

[Dave Foster]

@Steven Embree II, Nah you're in great shape! The beauty of the FHA/conventional small MF primary loans is that it makes for the perfect house hack - which you have done. The loan specifically recognizes that you are using part of the property (property must be 4 or fewer units) as your primary residence. So that portion (for you 25%) would qualify for your primary residence exemption. The other 75% is investment property and you absolutely can do a 1031 exchange on that portion. That's the power of this hack - part of the profit is tax-free and part is tax-deferred so there is no tax bill.

And if you want to then go a step further - 1031 exchange into another small MF where the value of the investment portion covers your 1031.  You can then move into the remaining portion.  And get a new primary residence paid for with your 1031 exchange alone.  Go have fun with your tax free primary exemption money.

Ask another lender.  I too think it is 12 months.

The IRS as the angel of death!  I've often wished a plague of frogs on them.

[Steven Embree II]

Thank you for the replies! I will absolutely be in contact with various lenders to make sure that my interests are maximized. It's also reassuring to get confirmation from professionals such as yourself that I'm on the right track!

I would also like to inform you for future reference that I was able to speak to a representative of the VA this morning and he assured me that the VA is indifferent to the tax code and that there are no such restrictions as laid out in the VA documentation. This is also my understanding. I've been able to track down the lender's documentation as provided with the Veterans Affairs, in case any of you or anyone else could be served by reviewing it.

Thanks again!

VA Loan - Lenders Handbook - Pamphlet 26-7

[Ryan Thomson]

@Steven Embree II I don't think you want to talk to a lender about these points. You should be talking to a 1031 intermediary and an accountant. Why are you talking to the lender about this? 

[Adam Bartling]

@Steven Embree II Are you making over $250K in profit on this house sale if Single , or over $500K profit if married?  If not why all this extra work?  Those are you capital gains limits.

[Basit Siddiqi]

seems like you should be able to take advantage of section 121 and 1031