1031 Exchange rental into rental turned primary residence

Beaverton, OR · Member since 2014 · 118 posts · 119 votes

I have a 4 plex I've owned as a rental for 3 years. Cost basis 300k, value 600k. Can I 1031 exchange this into a nice $600k SFH that I rent out, and later on move into to as my primary residence?

How long would I have to rent out the SFH before moving in as to not throw off "red flags"? What would be new cost basis be when it becomes my primary residence, the original 300k or the new 600k purchase price? When I sell the primary residence many years from now, would all those gains be erased due to the 500k tax free exclusion, or would I merely be deferring them? Other questions I didn't ask?

Thank you to whoever answers!

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Dave FosterBusiness Member

Qualified Intermediary for 1031 Exchanges · St. Petersburg, FL · Member since 2013 · 9k+ posts · 9k+ votes

@Jason Powell, absolutely you can!! And what a strategy to turn tax deferred into at least partially tax free!

There is no statutory holding period. The standard is long enough to demonstrate that your intent in purchasing the replacement property was to hold it for investment. Here's the extremes:

1. If you sign the closing docs in the morning and the moving van with your stuff is in the driveway that afternoon probably did not purchase it with the intent of using for investment.

2. There is a "safe harbor" given by the IRS at two years with some other caveats

3. A lot of folks will feel comfortable at anything more than a year so that rental income is on two consecutive years.

4. Any other time length that you and you accountant feel comfortable with

When you finally do sell that new property you won't get 100% of the gain tax free but you can get close. Once you have owned it for 5 years (because it was the product of a 1031) and have lived in it for 2 out of the 5 years prior to sale you can sell it and the following will apply.

1. You will prorate the gain between periods of qualified use (as your personal residence) and non-qualified use (as investment).

2. You will get the proration for qualified use tax free.

3. You will have to recapture all depreciation.

So, if you did the 1031 and used it for 2 years as a rental and then moved into it for 8 years you would get 80% of the gain tax free and have to recapture depreciation.

Not a bad plan at all!!!

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Dave FosterBusiness Member
Qualified Intermediary for 1031 Exchanges · St. Petersburg, FL · Member since 2013 · 9k+ posts · 9k+ votes
7y
@Jason Powell, absolutely you can!! And what a strategy to turn tax deferred into at least partially tax free!
There is no statutory holding period. The standard is long enough to demonstrate that your intent in purchasing the replacement property was to hold it for investment. Here's the extremes:
1. If you sign the closing docs in the morning and the moving van with your stuff is in the driveway that afternoon probably did not purchase it with the intent of using for investment.
2. There is a "safe harbor" given by the IRS at two years with some other caveats
3. A lot of folks will feel comfortable at anything more than a year so that rental income is on two consecutive years.
4. Any other time length that you and you accountant feel comfortable with
When you finally do sell that new property you won't get 100% of the gain tax free but you can get close. Once you have owned it for 5 years (because it was the product of a 1031) and have lived in it for 2 out of the 5 years prior to sale you can sell it and the following will apply.
1. You will prorate the gain between periods of qualified use (as your personal residence) and non-qualified use (as investment).
2. You will get the proration for qualified use tax free.
3. You will have to recapture all depreciation.
So, if you did the 1031 and used it for 2 years as a rental and then moved into it for 8 years you would get 80% of the gain tax free and have to recapture depreciation.
Not a bad plan at all!!!
The 1031 Investor5140 Reviews
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Jason Powell
OP
Beaverton, OR · Member since 2014 · 118 posts · 119 votes
7y
@Dave Foster Thanks for the great response! This is pretty darn slick actually. The one thing I missed in your response was what the "gain" will be viewed as upon the sale. I understand the prorations and recapture, but putting that aside....if I sold what would be my primary residence 10 years after purchasing it (8 years after moving in), for $1 million, would my gain be $400k ($1m sale minus $600k SFH purchase price), or would it be $600k ($1m sale minus $300k original 4plex purchase price)?
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Jason Powell
OP
Beaverton, OR · Member since 2014 · 118 posts · 119 votes
7y
@Dave Foster Also, not sure if you can answer on this public thread, but can you assist with 1031 exchanges in Oregon? (where I live and the property is located)
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Dave FosterBusiness Member
Qualified Intermediary for 1031 Exchanges · St. Petersburg, FL · Member since 2013 · 9k+ posts · 9k+ votes
7y
@Jason Powell, in general terms it will be the latter. Because when you do a 1031 the basis of the old property is carried forward and becomes the basis of the new property. Of course capital improvements, additional depreciation taken, and additional depreciable basis purchased all factor in as well. But your gain will be the gain from all the way back to the original property.
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Dave FosterBusiness Member
Qualified Intermediary for 1031 Exchanges · St. Petersburg, FL · Member since 2013 · 9k+ posts · 9k+ votes
7y
@Jason Powell, Since 1031 is a federal statute any QI can perform 1031 exchanges nationwide. But I'll take an in-forum chance and add that yes we do :)
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Jason Powell
OP
Beaverton, OR · Member since 2014 · 118 posts · 119 votes
7y
@Dave Foster Thank you very much for the quick and detailed responses. I will definitely PM you in the near future. I need to do a little penciling and planning with spouse, but I think this is a true gem for me at this particular time.
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Melody E Bergloff
CPA · UT · Member since 2019 · 55 posts · 19 votes
7y
@Jason Powell
I generally like this strategy and have come up with something similar that I have recommended to other clients that have property with a lot of built in gain (BIG). Essentially you are using the 1031 exchange as a way to defer your tax bill then transforming your rental into a primary residence to eliminate the gains (up to $500K for married filing joint (MFJ)).
I would definitely consult with a CPA. There are ways you can fall into a "booby trap" and potentially mess up your plan. For example, the IRS code has timing rules of how many days you have to reinvest the the proceeds from a 1031 exchange.

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Neal Collins
Developer · Portland, OR · Member since 2014 · 732 posts · 490 votes
7y
Nice thread @Jason Powell. There was some very useful nuggets that @Dave Foster dropped. What are you thinking you'd purchase? I've seen people with a house an acreage carve off the house to sell for the home owner tax benefit on sale and then exchange the acreage into a new property. It may be worth thinking about how far down the road you can kick that tax liability while also creating liquidity events along the way.
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Jason Powell
OP
Beaverton, OR · Member since 2014 · 118 posts · 119 votes
7y
@Melody E Bergloff Thank you. I did call my CPA today about this too. @Neal Collins I plan on just buying a regular SFH, would be awesome on 1/4 acre but probably can't afford more than that with the proceeds. My gain will only be maybe $350k max. I'm just looking for a decent home in a decent school district that I can spend the next 20 years in (even though I know statistically that won't be the case). I was going to buy an approx $600k home anyway within the next 2-3 years, so this just makes more tax sense to take it from "this pocket" as opposed to another. Looks like I'm from the same area as you too!
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