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Can a 1031 Exchange Involve Your Personal Residence?

Personal Residence

A 1031 exchange typically involves property you hold for investment, and not your personal residence. Is it ok to get involved doing a 1031 exchange on your personal residence? Most people think that your personal residence does not qualify for a 1031 exchange, but it can in some situations.

In the case when you sell a residence you've lived in for two of the last five years only $500,000 of the gain is tax free and that's if you're married. When you are single, it gets even worse, only 250,000 is tax free. Now in this case his is your personal residence, which you would think has nothing to do with a 1031 exchange, but it might. As stated above you know the two-of-the-last-five-years rule. Now ask yourself what was the property was used for during the other three years that you have owned it.

Let's say Charlie and Mary buy a house that they live in during the first two years, year 1 and year 2. At the end of year 2, they move out and turn the house into a rental property. Now they rent it out for years 3, 4 and 5. Now lets say they sell it at the end of year 5. Would this property be able to qualify for the personal residence exclusion? The answer would be yes, due to the fact Charlie and Mary lived there for 2 of the 5 years preceding the sale of the property. Now would this scenario also qualify for a 1031 exchange? The answer to this would be yes, because it was an investment property for the last year and 1 day before they sold it.

In the case (2) separate Tax IRS codes sections overlap like in the example above. In the sale of a personal residence the IRS actually lets you pick the code section that gives you the biggest tax benefit. Now lets decide which one you should you pick. In the example above, Charlie and Mary should treat the transaction as the sale of a personal residence. In doing so will allow them to take up to $500,000 of their tax gain off the table totally tax free and they'll never have to pay a tax on the money again. Now If they treated the sale as a 1031 exchange, they would have to end up paying tax on the gain someday even though the tax gain can be deferred right now.

Now in the case the gain from the sale of their house exceeded their personal residence exclusion. Charlie and Mary are allowed to "maximize their exclusion" and they can roll the rest of the tax gain over into a 1031 exchange. Lets assume that they sell the house/property for a tax gain of $600,000. They would first apply their personal residence exclusion of $500,000 to the gain, which still leaves a gain of 100,000 dollars. As a result they may rollover the extra $100,000 into a 1031 exchange and avoid being taxed on any of this $100,000.

Let's look at a different example showing a different scenario of these two IRS tax code sections. Say Charlie and Mary are selling a (4-Plex) home that they have owned for more than 2 years and during the time they owned it, they lived in 1 unit as their residence and rented out the other 3 units. In a situation like this they have a transaction that is both a combination of IRS tax code sections. As a result they have both the sale of their personal residence, for 1/4 of the sale, and a 1031 exchange for 3/4 of the sale. So in a nutshell, they have 2 transactions with this one particular sale.

Just because your involved in selling a residential property, there may still be a 1031 exchange situation that will help you defer those annoying taxes.

Can you do a 1031 exchange on an investment property and then move into the new property right away as your primary residence?

No, the intent of a 1031 exchange has to be for investment purposes only. The statute says that you can not move into the new property for a period of 2 years. There is a movement to overturn the ruling to 12 months, but as of right now it is advised to wait at least 2 years before moving into a replacement property.

Disclaimer: 1031 exchange made simple does not guarantee the performance of the QI's in our referral network and we can not be held liable for any misrepresentations or mistakes in regards to a 1031 exchange by one of the QI's that we refer to you. 1031 Exchange made simple does not provide tax advice nor can we make representations regarding the tax consequences of an exchange transaction. 1031 Exchange made simple is a 1031 QI Referral Network. 1031 made simple is not responsible (in any way) for the performance, creditability, and financial condition of any QI in our network. In this new economic environment it is imperative that all potential 1031 exchange customers do their own due diligence and research on any QI that they may use, on a 1031 exchange. Please verify and check the validity of the Bonding and Insurance of your QI. It may be wise to have your 1031 exchange accounts set up as separate, individual customer accounts. Our web site is to be used as a information based web site only. All parties doing a 1031 exchange must consult their tax advisors or attorney for this information.

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