1031 Exchange -- Moving In?

Question

I've been watching the forums for a long time, but haven't posted before. I couldn't find the answer to this question, so I'm sorry if it's been asked before.

I am buying a new rental property, and am going to 1031 exchange from an existing rental to fund the purchase. I am also thinking about moving into this house in a few years.

If I move into it later, is the capital gains bill due when I move in, or not until I sell the house? Is this a terrible idea?

Thanks!

Ashish Acharya · Answer

If you move in after 2 years, you will be fine.  There is a safe harbor period. See Rev proc 2008-16

Dave Foster · Answer

@David Miles spot on as usual from @Ashish Acharya.  The two year period is not statutorialy mandated but if your calendar permits then the safe harbor of two years is not a bad guarantee.

Not only might this be a good idea for living.  But a couple other good things happen.

1. Simply moving in doesn't trigger the tax.  So you'll be living in a house partially paid for by the deferred taxes (thank you silent partner Uncle Sam).

2. Once you have owned that property for 5 years and have lived in it for at least two out of the 5 years prior to sale you can sell it and take a prorated amount of the gain tax free.  If you bought it and used it as rental and then moved in for 3 years you could sell it and get 3/5ths of the gain tax free.  You do still have to recoup depreciation.

But still the ability to turn at least a portion of 1031 gain into tax gain is a big deal.

Dave Foster · Answer

@Guy Yoes, the direction you convert makes a huge difference.

1. If you buy and live in your primary for 5 years and then sell it so that . you have still lived in it for 2 out of the 5 years immediately prior to sale then you still qualify for the full primary residence exemption even though the property is being used for investment.

2. If you buy and live in your primary for 5 years and sell after the window where you have lived in it for 2 out of the 5 prior to sale then you lose the primary residence exemption but you can 1031 because it is currently being used for investment.

3. If you buy a rental and use if for rental and then convert it to your primary residence then the rules I described take effect.  You can take a partial primary residence exemption but you may not do a 1031 because it is now being used as your primary.

4. If you buy a rental and then convert it to primary and live in it for at least two years and then move out and convert it back to a rental and in a year sell it you would again qualify for a partial primary residence exemption. And now you could also do a 1031 because it's current use is investment.

The requirement for the primary residence exemption is 2 out of the previous 5 as your primary.  the requirement for 1031 is current use as investment.

So.... For our friends sitting on more than $250K/$500K profit in your primary residence.  Here's the tip o the day!  Move out of your primary residence for a year or two.  Then sell the property (no investment property) and do a 1031 exchange but take boot of $500K (if you're married - $250K if single).  Normally this boot would be taxable but since you qualify for the primary residence exemption it will be tax free.  The 1031 will shelter the rest of the gain and depreciation recapture.

It's a first world problem if you've exceeded the gain limits on your primary residence.  Thank heavens there's a first world solution  with a little patience :)

Guy Yoes · Answer

@Dave Foster

Dave-

what if I lived in my house for 5 years and then rented it for 3-5 more years. IF I 1031X it, would I still have to pay some taxes or would it be considered a long term rental?  Also could I deduct the usual rental costs while it was rented?

Thanks again Mr. 1031X Guy!

Robert Nelson · Answer

@David Miles

Talk to your accountant and a 1031 exchange. I am in a sort of similar situation and tax laws changed a couple years ago that affect these kinds of situations.

Dave Foster · Answer

@Guy Yoes yeah.  Most folks don't realize it.  But a property qualifies for a 1031 exchange based on it's current use.  It qualifies for the primary residence exclusion (partial or full) if you have lived in it for 2 out of the 5 years prior to sale.  So it is possible that a property is currently an investment but also qualifies for the primary exemption.  Awesomely powerful!!!

The primary residence portion carved off is tax free winner winner chicken dinner.  the 1031 portion carries forward indefinitely the gain and depreciation recapture.

However, the one gotcha is that if you sell a property without a 1031 that has pent up depreciation recapture you will have to pay that.

Guy Yoes · Answer

@Dave Foster

Thanks for the information! So, a simple process like a 1031X can be used with my primary residence as well as a rental.

Do the taxes and depreciation carry over to the new property? Will future 1031x's  just pile depreciation and cap gains higher until I sell the property?

David Miles · Answer

Thanks for the help - I'll take a look at that document, but thank you for the summary. You guys always provide great advice.

1031 Exchange --> Moving In?

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