Tax implications of a 1031

6 Replies

Tax implications of a 1031

I am trying to understand the tax implications of doing 1031 exchange on an investment property.

I have an investment property that I lived in for 8 years and then rented for 5.

I will have about 60K in gains and I depreciate about 5K/year on it.

I am considering rolling it over into a larger rental and then slowly improving the property.

Do you have to pay depreciaion recapture and capital gains on the years that you lived in a property or only the years that it was rented, if you do NOT qualify for 2-of-5 rule?

If I move into the 2nd property after a few years, how does the "capital gains tax exclusion" work with the liability that gets rollod over in a 1031?

Any advice or guidance would be appreciated.


@David Green , What you have is an investment property pure and simple.  You're right you do not qualify for the exclusion of sec 121 so if you sell without a 1031 you would pay all tax on the gain and depreciation recapture.

If you do a 1031 then your adjusted basis carries forward into that new property.  You defer recognition of the gain and you defer depreciation recapture.  Your purchase of more than you sold actually increases your depreciable basis.

If you decide to move into it in a few years you simply change the use and that does not trigger a recognition of gain.  So as long as you owned it again the gain and depreciation recapture would be deferred.

When you finally sell that property after 1031ing and then converting it into your primary residence you will get a partial 121 primary residence exclusion.

1. In order to do so you must have owned the property for 5 years as well as have lived in it for 2 out of the previous 5.

2. When you sell you will prorate the gain between periods of "qualified use" (as a primary) and "non-qualified use" (as investment).  The amount allocated to qualified use you will get tax free within the $250K/$500K limitations.

3. You will still have to recapture all depreciation at that point.

So, if you rented it for two and then moved in for three and sold it you would get 60% of the gain tax free and would pay tax on 40% and recapture all depreciation.  Not as sweet as the old days but still not a bad plan.

@Dave Foster Thanks so much for that response!

It sounds the number of years I rented the original property does not have any bearing on calculating %TaxFreeGain on the 2nd property.  

If I were to roll over 60K in gains over into a new property that cost 300K and sold it 10 years later for 400K I would only have to pay capital gains on 80% of 160K?  Rent 2, Live in 8. 

@David Green , yep.  Plus of course the depreciation recapture.  Although it's not entirely tax free it's still not a bad idea.  And of course the longer you live there the greater the amount of tax free gain.

@David Green - There's no depreciation allowance available on your primary residence.  So no tax break - only on investment property.  But there's also no depreciation recapture on the back side when you sell.