I am going to put my rental property on the market and am looking to take the equity from it to buy a new home (primary residence). Question is can I use the 1031 exchange for this or does the new home have to be a rental? Also what strategies would one suggest I look into to avoid the capital gains tax on profit from the rental.
It can be done, but the key is your intention at the time you acquired the replacement property. ... If so, you may be able to re-characterize that 1031 exchange-deferred gain on investment property into gain on your principal residence and enjoy some or all of the $250,000 or $500,000 exclusion on its sale.
Check this article out it should help.
@Tam Le , As @David Rhodes said, it can be done. But you have to be patient. The 1031 exchange is used to sell investment property and using a specific process purchase new property that you also intent to hold for investment use. However, you can always change your intent and the use of the property without incurring a tax hit.
But what needs to be clear is that you are "changing your intent" and that your intent from the beginning was not to purchase a primary residence. If you do the 1031 exchange and the next week the moving truck pulls up with your furniture what was your intent? Clearly to purchase a primary residence and your 1031 would be disallowed if ever audited. the other extreme is a safe harbor the IRS has given for a two year hold with some other requirements. If you follow that then they promise to not disallow.
Where's the middle ground? That's really up to the individual circumstances. Most people feel pretty good at any thing more than a year.
So if you've got patience then you can follow through with your plan. Because the property is a conversion of a former investment property purchased with a 1031 exchange you won't get the full primary residence exclusion when you sell. But you get a pro-ration tax free.
@Tam Le Usually you can't, because as per the rules, properties involved in 1031 exchanges must be held for productive use in trade, business or for investment. In other words, personal properties (place of primary residence) don't qualify for a 1031 exchange. However, your replacement property doesn't need to be a rental property as well. What IRS generally check is the investor's intent behind the investment. Therefore, you can acquire any investment property against your relinquished property. In case you acquire a place of primary residence as your 1031 exchange replacement property, you may need to rent it out for a couple of years in order to show your intent and successfully complete your exchange. Later, you can shift to your new home and use it as your primary residence.