1031 Exchange to Owner Occupied multi-family

42 Replies

I'm curious to know if it is possible to use a 1031 Exchange to go from a non-owner occupied multi-family to an owner occupied multi-family. Are there rules prohibiting that?

The occupancy of the real property is not a factor in 1031 exchanges. The new asset must be a like asset, in other words real estate can only be swapped for real estate not commodities or equities. You should be fine.

i disagree with Dion. Occupancy is a factor in 1031 exchange. You cannot exchange into an owner occupied residence. Investment use and personal use are not like-kind real estate.

If you find a multi-unit property you want to exchange into, and you want to live in one of the units as your primary residence, you can still exchange into the portion of the property that will be your investment rentals.

For example, you found a four-plex you want to acquire with a 1031 exchange. You want to live in one of the units and use the other three as rentals. Allocate 75% of the cost of the property to the investment rentals, then use your exchange funds to acquire those three units making sure that the purchase price for those three units is greater than or equal to the value of the property you relinquished.

Money to buy the unit you want to live in has to come from outside your exchange.

Dave T is absolutely right Section 1031 only applies to investment property, it does not apply to:

personal residence
second homes, or third, 4th etc
vacation homes
dealer property

If the relinquished property is partially personal use and partially investment use, then the Section 1031 would only apply to the investment portion of the property.

Some have done a Section 1031 from one investment property to another investment, that eventually becomes a personal residence, but as you would expect there are IRS rules that govern that situation also.

So, sorry @Dion DePaoli , but it doesn't quite work as you thought.

Great post and Great replies gentlemen. Just learned something...

@Dave T is right on the money. I would add one more comment. You could 1031 Exchange out of investment property and then 1031 Exchange into property that you intend to hold for investment purposes. You can change your intent/convert the use of the property from investment to your primary residence after you have rented it long enough to prove that you had the intent to hold for investment. Some advisors recommend 12 months. In this case, I would probably recommend being more conservative and renting it for 24 months.

Thanks for the replies! Interesting to know a bit more about this topic.

The property being relinquished is NOO. The replacement is multi-family with one unit possibly being claimed as a primary residence.

You can combine section 121 and section 1031 in this case. The property's utility can be subdivided, say by square feet or through separate appraisals, etc. So then section 121 can offer tax shelter on the primary residence unit and section 1031 can provide shelter for the rest of the property.

@Dion DePaoli - I don't believe that will affect this transaction that the OP described, until maybe when the newly acquired replacement property - the partly owner occupied multi-unit - is later sold; that is when section 121 comes into play. Section 121 will have no bearing on the relinquished non-owner occupied property.

just to make sure I am reading this correctly, you are not able to do a 1031 exchange on an owner occupied property. Correct?

@Eric Lasley

Yes, see my post above, Section 1031 only applies to investment property.

However, the personal residence Section 121 is even better as the first $250,000 or $500,000 (if married or jointly owned) of long term capital gains is TAX FREE. Can't do better than tax free. There of course are rules that apply.

@David Krulac
thanks...i'm a big time newb and not that smart when it comes to all of this stuff. just wanted to make sure i was reading it correctly.

my problem right now is I have only been in the house a year. I bought it before I knew anything about investing and I would really like to offload it and get into a owner-occupied MF. I was hoping that the 1031 might be a possible avenue with which to get that done. alas, back to the drawing board

@Dion DePaoli - The relinquished property is a non-owner occupied property as you pointed out, so the 121 exclusion will not apply. The 121 exclusion only applies to the sale of a primary residence where the owners have lived in the property for at least 24 months out of the last 60 months. The replacement property is a "split-use" property and would qualify for the 121 exclusion when sold sometime in the future.

Would you be able to do a 1031 exchange on an owner occupied apartment into another owner occupied apartment? I'm assuming you would need separate appraisals, and the exchange would only apply to the non occupied units.

Also, if you have lived in each of the units in order to rehab them, does that eliminate the possibility of doing an exchange?

Originally posted by @Eric Lasley :

just to make sure I am reading this correctly, you are not able to do a 1031 exchange on an owner occupied property. Correct?

You maybe able to use Section 121 to avoid paying taxes on your OO property. If you have lived there 2 of the last five years as an owner occupant, you could avoid taxes on 250k of gain. If married, it would be 500k of gain. You should consider that route instead of an exchange. 121 eliminates the tax up to those numbers whereas a 1031 exchange defers taxes.

Mark

@Mark Creason & @Laura Janosko

Its not a case of choosing between IRS Section 1031 or IRS Section 121.  They are mutually exclusive.  121 is for owner occupant only, and 1031 is for non-owner occupied only.

In the case where you owner occupy one unit in a multi, you can 121 the owner occupied unit only and 1031 the non owner occupied unit(s).  The rules are different for the two different IRS sections and you need to follow the requirement to the letter for it to be a valid exchange/forgiveness. 

Originally posted by @David Krulac :

@Mark Creason & @Laura Janosko

Its not a case of choosing between IRS Section 1031 or IRS Section 121.  They are mutually exclusive.  121 is for owner occupant only, and 1031 is for non-owner occupied only.

Eric stated he has an OO house. He would not be able to do a 1031 exchange on the property, unless he rented it for a portion of the last 5 years. We sometimes focus on tax deference, that we forget about tax avoidance. I was being polite with my response.

Mark

But @Laura Janosko mentioned exchanging a owner occupied multi unit immediately above your post.  Just wanted to clarify since people were talking two different things.

@Mark Creason , @Laura Janosko , @Mark CreasonThere actually is one time when 1031 and 121 are not mutually exclusive and both would apply on the same property.  This is in the three year period following conversion from primary residence to investment.  if the property is sold during this time it would be possible to 1031 the property since it is fully investment and take up to $500K in boot that would normally be taxable but in this case be offset by the primary residence exclusion of sec. 121 since they would also qualify for that having lived in the property for 2 in the previous 5 year period.

If the gain on your primary residence eclipses $500K then it is a strategy worth looking at.

Originally posted by @Dion DePaoli :

The occupancy of the real property is not a factor in 1031 exchanges. The new asset must be a like asset, in other words real estate can only be swapped for real estate not commodities or equities. You should be fine.

Dion,

Occupancy is a factor in a 1031 Exchange.  Properties must be held for rental, investment or business use.  They can not be held for personal use such as a primary residence, second home or vacation home. 

Originally posted by @Dion DePaoli :

The property being relinquished is NOO. The replacement is multi-family with one unit possibly being claimed as a primary residence.

You can combine section 121 and section 1031 in this case. The property's utility can be subdivided, say by square feet or through separate appraisals, etc. So then section 121 can offer tax shelter on the primary residence unit and section 1031 can provide shelter for the rest of the property.

Dion,

The OP could sell a rental or investment property that is 100% rented and then 1031 Exchange into another rental or investment property that is both rental and a primary residence.  The percentage or portion of the new property that is held/used as rental or investment property must have a fair market value that is equal to or greater than the total fair market value of the Relinquished Property that was sold. 

Originally posted by @Eric Lasley :

just to make sure I am reading this correctly, you are not able to do a 1031 exchange on an owner occupied property. Correct?

Hi Eric,

You are correct.  1031 Exchange only applies to rental, investment or business use property. You can certainly exchange into property that later becomes your primary residence, but your initial intent must be to hold for rental or investment purposes.  It is also possible to have split use property where a percentage is held for investment purposes and only that percentage would qualify for 1031 Exchange treatment.

Oh, I understand. Thank you all for clarifying. Can you only do the 121 exchange after you have owned the property for 5 years?

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