1031 exchange duplex to single family

[Kyle Smith]

Hello BP, 

Hoping some of you experts could weigh in on this one or point me to where it's been asked before on the forums.

I have rental property that I'm planning on 1031x this year. I'm aware of the rules for finding like properties, 45 days, etc.

Here's the catch, I'm also looking to purchase a SFR near the beach and wondered the following: Could I 1031 my current MF units (duplex) into a SFR to be used in the short term as rental property. Then when the time allows (2-3 years down the road) move into the SFR as a personal residence? Would this trigger tax liability at this point? Would I need to refinance?

I'm not trying to do anything illegal, it just seems like as long as I don't want to change the loan terms I'm basically 'renting' to myself?

[Dave Foster]

@Kyle Smith, What you're talking about is a conversion of an investment property into your primary residence.  Not illegal.  Happens all the time.   Change of use does not trigger a tax event.  There's no statutory holding period before you can move in.  But as @Matt K.said your intent in 1031ing into that property must be to hold for investment use.  Later your intent can change.

The IRS gives a safe harbor for this of 2 years.  A lot of folks are comfortable with over one year so it is on two consecutive tax returns as investment.  The specifics of your situation will determine what's appropriate.

A couple of things to know about a conversion of a 1031 investment into your primary residence.

1.  When you do sell, in order to get part of the gain tax free you have to have owned the property for a minimum of 5 years.

2. You will have to have lived in the property for 2 out of the 5 years prior to sale.

3. You will only get to allocate the gain between actual time of personal residence (qualified use) and actual time as investment property (non-qualified use).  So if you bought it and rented it for 2 years and then lived in it for 3 years you would get 3/5ths of the gain tax free up to the exclusion limits.

4. You will have to recapture depreciation taken.

Other than those stumbling blocks it's a good plan and one that many have chosen.