can you 1031 an investment property and then use as second home

Question

If one changes the use of an investment property to a second home .. I guess the question is what is the tax ramifications of recapture since I have no basis do I pay it the next tax year or would it be paid when I actually sell it .. or since it will be in my trust and go to the kids what then..

thanks in advance I guess i could ask Chat but I am sure there are investors on this site and CPAs that know this off the top of their head.

Dave Foster · Answer

@Jay Hinrichs

Under the safe harbor of Rev. Proc. 2008-16, the IRS will not question investment intent if the property is held for investment for at least two years, rented at fair market value for at least 14 days in each of two consecutive 12-month periods, and personal use stays within the safe-harbor limits. This is not a requirement. It is the criteria under which the IRS will guarantee your investment intent. And this rev proc provides the framework for the conversion to a personal residence from investment.

When you later move in and sell, the sale is where the tax consequences matter. Future depreciation is suspended, and depreciation taken during the rental period is still taxable when it is sold. You also do not get to ignore the rental period of the replacement /converted property. The conversion rules reduce the amount of gain eligible for the exclusion. But if you satisfy the principal-residence test — generally owning the property for at least five years and using it as your primary residence for at least two of the five years before sale — you can still qualify for a partial §121 exclusion for the period it was your home.

Or, as you mentioned, you can leave it to your heirs, and they will get the step-up in basis, which includes depreciation. It's a great estate planning tool. One of the keys is deciding which property to convert. If you plan to convert and later die owning it, then the property with the greatest depreciation makes sense. If you're converting to later take the partial 121 exemption, then you want to pick the one that has the lowest depreciation taken. Since that can't be relieved.

Jason Malabute · Answer

Switching a rental over to a second home isn't a sale, so it doesn't trigger recapture on its own and there's nothing to report next year just because you stopped renting it. What it does is stop the clock: no more depreciation and no more rental deductions, but the depreciation you already took stays attached to the property and your basis doesn't reset. On a later taxable sale that prior depreciation generally comes back as unrecaptured Section 1250 gain, taxed at a maximum of 25 percent, with the rest treated as regular capital gain, and the years it sat as a second home don't wash any of that away. For your plan the good news is that if you still own it at death and it passes to the kids, the step up in basis to fair market value generally wipes out the built-in gain and the depreciation piece along with it. The trust is the part worth confirming, since a revocable living trust generally preserves that step up but not every arrangement does. The exact answer turns on your own facts, so have your CPA or tax advisor look at the specifics.

Ashish Acharya · Answer

Switching an investment property to a second home is not a sale, so it does not trigger depreciation recapture by itself. Recapture is a sale-time event, not a use-change event. Nothing gets reported the next tax year just because the use changed.

What the conversion actually does is stop the clock. Once it is a personal second home, you can no longer depreciate it or deduct it as a rental, but all the depreciation you already took stays attached to the property. Your basis does not reset. So if you later sell, you still owe recapture on that prior depreciation (taxed up to 25 percent as unrecaptured Section 1250 gain), plus regular capital gain on the rest. The years spent as a second home in between do not erase any of it.

Now the part that matters for your plan. If you hold it until you pass and it goes to your kids, they generally get a step up in basis to fair market value at death. That step up wipes out the built-in gain and the depreciation recapture along with it, so neither you nor they pay that tax if it transfers at death rather than being sold during your lifetime. The trust matters here too, because whether the step up applies depends on how the trust is structured, a revocable living trust generally preserves it, but not every trust does.

So the short version: converting now costs you nothing today, selling later brings recapture back, and dying while holding it can eliminate it entirely. It is worth confirming your trust setup actually delivers that step up, since that is the whole ballgame for passing it to the kids. Happy to connect!

Jay Hinrichs · Answer

chat says rent it at least 14 days a year for 2 years then your 1031 is protected and for me the property then gets inherited by my kids and they can then do whatever they want with it.. and chat further said if its a STR I can use it 14 days a year plus as @johnunderwood mentioned on this same question I had days your working on it do not count against the 14 days.. so this changes my entire strategy Hoping a CPA will chime in here to confirm

Aristotle Kumpis · Answer

I have clients that ask me a similar question. A common question is can I 1031 into an investment property and then move into it as my primary? The answer is yes. Most CPA's will tell you to rent it for 2 years or more. Then you can move into it as your primary. When you go to sell it, there is no recapture tax because you are now claiming it as your primary.
For a second home, Otto

can you 1031 an investment property and then use as second home

can you 1031 an investment property and then use as second home

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