1031 Exchange it No?

4 Replies

Hey BP Community, We have a home that has been in the family and has not been declared as a rental for tax purposes due to various family members and friends living in it. It has come time to sell, and the question is whether or not we need a 1031 Exchange in order to avoid Capital Gains Tax? Thank you so much for any help!! Cedric

@Cedric Van Duyn , I'm not sure that's the right question.  I think the question is "Does this qualify for a 1031 exchange.  That's the only way you're going to shelter capital gains because as described the property does not qualify as your primary residence.  You (the owner) must reside in the house for 2 out of the 5 years prior to sale to get the sale tax free.

Unfortunately you're also on the bubble for a 1031 without some clarification of intent.  If you owned that house so that friends and family had a place to stay that is not productive use in business investment or trade and would not qualify for 1031.  If you bought that house to use productively as an investment whether for rent or appreciation or business marketing etc then the property would qualify for 1031.  The fact that it's not reported on your Schedule E makes establishing the investment intent sketchy for sure but not a statutory requirement.  Not that you couldn't have had the intent of appreciation but the IRS doesn't like inconsistency.  Tough call.  

Your question leaves out a few key points.

We have a home that has been in the family... Does this mean you, or you and your spouse own it. Or is it owned by extended family? 

How long has it been used for various family members to live in? 

I realize that a lot of your region has had great appreciation but I think you're still allowed up to $500K tax free if you meet the 3/5 occupancy rule. Even if you exceed the $500K cap you would only own LTCG on the amount over that.

Thank you for the helpful comments and clarifications. The SFH is owned by my father-in-law. He and his family lived in it for many years. He bought a new house around 1995 and allowed one of his sons to live in it for several years, paying only to cover the mortgage.

Subsequent to his son purchasing his own home approximately 2 years ago, the house has been mostly empty except for a few months when a family friend stayed in it and only paid to barely cover utilities. The house is occasionally used for church Bible Study Meetings (the son leads a church in the area).

The house has been "in limbo" for a while and my father-in-law is trying to figure out if he needs to do a 1031 Exchange in order to reinvest the money in a rental investment strategy.

The house is paid off and is worth over $500,000 and it is located in West Covina, CA

@Cedric Van Duyn , If the property is on your father's schedule E it's basis has probably depreciated to almost 0.  So even if it hasn't appreciated in years (doubtful) there would be  almost $500K of depreciation to recapture.  

It's obviously  up to your father and his accountant to make the final call on the applicability but discounted rent aside, the occasional tenant gives strength to an argument of holding for appreciation.  And the use by the church could easily be classified as productive use in trade.  

The only thing that gives me pause that I'd want your father to verify is whether the property is on the Schedule E or A and what kind of heartburn that causes the accountant.

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