1031 Tax Deferment possible for Primary?

4 Replies

We’ve been told by our real estate agent and by a lender that we can use the 1031 exchange for our primary, however, everything I’ve ever known about the 1031 is that it is ONLY for investment or business purpose, NOT for primary. I’m trying to figure out if there is some loophole or something they may be doing in order to use it successfully on the primary? I keep insisting it’s not possible they keep insisting it is. We’re going in circles and it’s driving me crazy! Has anyone ever used a 1031 somehow on their primary residence? (We are NOT planning to turn the new property into an investment) Thanks so much!

Hi @Shannon Bae

The relinquished property sold and the replacement property acquired must be held for rental, investment or business use to qualify for 1031 Exchange treatment.  Properties held and used as a primary residence, second home for personal use, or vacation home for personal use, etc., will not qualify for 1031 Exchange treatment as they do not satisfy the Qualified Use requirement.

The sale of your primary residence falls under Section 121 of the tax code.  It is often referred to as a 121 Exclusion.  This allows the property owner to exclude up to $250,000 in taxable gain (per person, $500,000 for a married couple) from the sale of the primary residence if they have owned and lived in the property for a total of 24 months out of the last 60 months (2 out of last 5 years). 

However, the intended use of a property can be changed.  You could move out of your primary residence and convert it to rental property, rent the property out for a sufficient period of time to provide intent to convert and hold as rental property, and then it would qualify for 1031 Exchange treatment.

The IRS issued Revenue Procedure 2005-14 that specifically covers this.  Here is how it could work.  Let's say that a husband and wife own a primary residence, they have owned the primary residence and lived in it for over two (2) years, and the primary residence has $750,000 in taxable gain (profit).  They could move out of the primary residence, convert it to rental property, rent for about two years to demonstrate intent to convert and hold as rental property, and then sell.  They would be able to exclude $500,000 in taxable gain ($500,000 out of the $750,000) and they would also be able to complete a 1031 Exchange and defer the balance of the taxable gain ($250,000) into rental property.  The taxpayer(s) have a three (3) window beginning on the day they move out of the house and convert to rental property to complete this transaction and still qualify for both the 121 Exclusion and the 1031 Exchange. 

Thanks for the reply @Bill Exeter ! Obviously, this is your area of expertise so I appreciate the response! Ok, you’ve confirmed what I know and have researched. I cannot figure out how/why the agent AND the lender keep insisting I won’t have to pay tax on the profit above the $500k from Section 121..baffling..

Originally posted by @Shannon Bae :

Thanks for the reply @Bill Exeter ! Obviously, this is your area of expertise so I appreciate the response! Ok, you’ve confirmed what I know and have researched. I cannot figure out how/why the agent AND the lender keep insisting I won’t have to pay tax on the profit above the $500k from Section 121..baffling..

If you moved out, rented it fir a year or two which makes an investment, then you could sell, using the 121 exclusion fir the $500k and 1031 the remaining profit into an investment property….that’s the only way.  If you simply sell now, no.

@Shannon Bae

I would fire your agent/lender if they are providing incorrect/misleading tax advice.
If they are saying that just to get a sale...no telling what else they are doing.

Regarding your personal residence, section 121 exclusion or QOF would be the tax deferment / tax exclusion tax strategies to use.