If I sell a fourplex, roll the gains (1031) into a single-family home purchase, rent it out for a couple years, then live in the house for two consecutive years, can I completely avoid capital gains from the fourplex when I sell the house?
@Kevin Futrell , close but not quite. When you sell the fourplex you'll get 25% of the gain tax free if you have lived in the one unit for at least 2 out of the 5 years prior to sale. You'll 1031 the other 75% into the single family investment property. Once you've used it for investment long enough to have established your intent of investment you can move into it converting it from investment to your primary residence. The length time this takes is however long it takes you to establish your intent. There is a safe harbor from the IRS at two years. A lot of folks feel like anything more than a year is fine.
Once you move into it then there are a couple of differences between a normal primary residence sale and one when the property has been converted from a 1031.
1. You have to have owned the property for at least 5 years.
2. You have to have lived in the property for 2 out of the 5 years before you sell it.
3. You'll have to prorate the gain between periods of qualified use (as primary residence) and non-qualified use (as investment).
4. You'll also have to recapture any gain attributed to depreciation.
So if you sold a property and 1031d it into a new property. Use it for rental for two years. Then moved in for three years you have owned it for five years. You have lived in it for two out of the five prior to sale. You would be 3/5ths (40%) of the gain tax free and have to recapture depreciation.
Still a great plan. You just have to plan accordingly.
Thanks. It reads as though the recapture never goes away, it continues to build from one property to the next.
@Kevin Futrell that's correct. But it stays "suspended" or deferred as long as you own the property or continue to 1031. So you may lose the tax break but you won't have to recapture. Couple options that usually accompany that.
1. When clients 1031 they'll frequently purchase larger properties. The requirement to carry over the basis is only the value of the sale. So any additional purchase above that adds additional depreciable basis.
2. At the end of an assets depreciable life the decision is usually made to turn it into a passive cash flow mechanism like a NNN property or a DST/TIC. It then acts like an annuity. You don't get depreciation as a write off. But you get cash flow. And cash in the hand is better any day :)