2 Rentals -> 1 Retirement Primary Residence

General Real Estate Investing
7moFollow

2 Rentals -> 1 Retirement Primary Residence

Matthew Dermody
Member since 2018 · 1 post · 0 votes

Hello everyone,

I'm a service member mapping out my path to a retirement home and could use some experienced eyes on my plan. I've done some research and have a strategy, but I want to do this in the most legally sound and tax-efficient way possible while avoiding unforeseen pitfalls.

My Goal:

To consolidate my two current rental properties into a property that will initially serve as a rental and eventually become my primary residence in retirement.

My Plan:

Here is the step-by-step strategy I've put together:

  1. Sell my two rental properties (VA Loans) and execute a 1031 exchange, rolling the proceeds from both sales into the purchase of a single investment property.
  2. Operate the new house as an investment property.
  3. Make upgrades to the property while renting as an expense for a tax advantage.
  4. Convert the property from an investment property to our primary residence.

Questions and Potential Pitfalls

This is where I could really use your help. I'm looking for feedback on my plan and answers to some specific questions about the execution.

1. Conversion to Primary Residence: I want to ensure a smooth and legal transition that preserves future tax benefits.

  • How do I legally convert my rental from an investment property into a primary residence? What are the legal and financial steps I would need to achieve the conversion?
  • How do I minimize taxes like the depreciation recapture? My understanding is that the Section 121 Exclusion can help:
    • How can I ensure I'll eventually qualify for the full Section 121 primary home sale exclusion after it has been a rental property for several years
  • I plan to hold the new lake house in an LLC for liability protection while it's a rental. If I put the retirement property into an LLC when it's a rental property, does that further complicate the legal transition to my primary residence later on? How do you "take it out" of the LLC to make it your home?

2. The 1031 Exchange: My plan hinges on this, but a 2-into-1 exchange seems complex.

  • Timing: What are the biggest pitfalls in coordinating the sale of two properties to meet the 45-day identification and 180-day closing deadlines for a single replacement property? Any strategies to align the timing and avoid having the rentals sit vacant for too long?
  • Seller Negotiations: Are sellers generally open to rent-back agreements or delayed closings to help buyers like me align their 1031 timelines?

3. Upgrades and Tax Strategy: My plan is to upgrade during the rental phase.

  • What should I be tracking to correctly handle depreciation recapture taxes when I eventually sell decades from now?

Any thoughts, warnings, or personal experiences you can share on this plan would be immensely appreciated. Thank you

0Reply
102 views

4 Replies

Jump to latestLatest
  • Arman AhmedPro Member
    Real Estate Agent · Columbus Cleveland Dayton, OH · Member since 2024 · 2k+ posts · 929 votes
    7mo

    @Matthew Dermody

    You’re thinking about this the right way, and the strategy can work if the execution is tight. The biggest risks are protecting the 1031 intent by operating the new property as a true rental for a solid period, coordinating the two-into-one exchange timing with a strong intermediary and tax advisor, and planning the future primary-residence conversion so Section 121 benefits stay intact. Many investors in Midwest markets follow this exact path because lower purchase prices and steady rental demand make the hold-then-convert strategy much easier to sustain long term.

    [email protected]614-418-6081
    0Reply
  • Alex Olson
    Real Estate Broker · Kansas City Metro · Member since 2015 · 2k+ posts · 1k+ votes
    7mo

    Having an agent/broker on your side that knows how to navigate and negotiate different closing dates and line them all up for the same goal is very important. It is definately doable and I see it happen all of the time. 

    0Reply
  • Fulton Abraham Sanchez
    CPA| New Clients Welcome| 50 States · Member since 2016 · 435 posts · 93 votes
    7mo

    @Matthew Dermody, hi. Strong plan overall, just be careful with timing, structure, and long-term tax impact.

    A 2-into-1 1031 exchange is allowed, but coordination of closings and the 45/180-day deadlines is the biggest risk, so working closely with a qualified intermediary and identifying backup properties is key. When converting the property to your primary residence, the change happens when you genuinely move in, but your ability to use the Section 121 exclusion later depends on holding periods and prior 1031 rules, this needs advance planning.

    Depreciation recapture can't really be avoided, so accurate tracking of basis, depreciation, and capital improvements is critical. Also, holding the property in an LLC may complicate future primary residence treatment and financing, so structure should be carefully evaluated before moving forward.

    0Reply
  • Dave FosterBusiness Member
    Qualified Intermediary for 1031 Exchanges · St. Petersburg, FL · Member since 2013 · 9k+ posts · 9k+ votes
    7mo

    @Matthew Dermody, Good plan.

    There is no statutory holding period stated before you can convert your property to your primary residence, but you do still have to demonstrate your intent to hold the property for investment use. There is a safe harbor from the IRS that guarantees that the IRS will not question your investment if you have used the property for investment for two years, rented it for at least fourteen days in two consecutive years, and used it only minimally for personal use. Converting from an investment into your primary is as simple as moving in and changing where it is reported on your tax return.

    If you later decide to sell the property as your primary residence, you can still qualify for the 121 exclusion, but you won't get the full exclusion; it will be prorated between the number of years it was used for investment and the years you lived in it. And you would still have to recapture any depreciation from when it was used for investment.

    Ownership determines how the property gets treated (taxed). One of the requirements of the 1031 exchange is that the taxpayer for the old property must be the same as the new investment property (this means what tax return reports it). If the LLC is disregarded or non tax paying LLC, then you are still the taxpayer, and it wouldn't interfere with the conversion to your primary at all.

    Doing a consolidation exchange really isn't that much more complicated. You just have to watch your timelines. And your qualified intermediary will be your guide throughout the process.

    Here are a few ways you can navigate and make your exchange smooth, and your qualified intermediary will be your guide throughout the process. Since your goal is to combine two sales, your timeline will start when the first property is sold, and you will need to sell both properties within that timeframe.

    -You could try selling them as a portfolio to an investor, even though you might not get as much, selling them individually, but it would make your exchange timelines less stressful.

    -You could also negotiate an extended closing on the sale or purchase and add contingencies to ensure your properties are sold and that you don't lose your exchange. If you need to motivate your buyers or seller you might even want to add cash to the deal. Do the hard thing first - If finding the right replacement is harder, then get it under contract and then sell your old ones. If it's a buyer's market, then sell and try to time their closings as close as you can first.

    One thing that hasn't been mentioned here is that you want to be careful with improvements and trying to classify them as repair expenses for the immediate tax benefit. The IRS has some pretty strict rules about what can be expensed. And what has to be capitalized and added to your basis. Your accountant will guide you here.

    The 1031 Investor5137 Reviews
    WebsiteView Page
    0Reply
Join the conversationCreate a free account to reply, vote on answers and follow this thread.
Log InJoin for Free