Taking primary residence in a 1031 exchange property

[Tina Lee]

I purchased my investment property in Nov 2021 as a 1031 exchange in Seattle.  I currently live in Visalia California but just got a job in Seattle and will be moving there in April.   It has been a challenge to rent out my investment property with cashflow since the mortgage is high but I currently have it rented out with some cash flow.   The current lease ends in April and I would like to move in to the property since  rent market has gone down significantly and it will be even harder to rent it out with cash flow.   I have consulted 2 lawyers and my CPA regarding moving into my 1031 exchange property and they have told me different things.

The tax attorney told me not to move in until 24 months from the purchase if I don’t have to and IRS will not challenge my 1031 exchange. He called it a “safe harbor”. So basically he told me not to move in until December this year which will be right after 2 years since the exchange and I will be safe even if I get audited. IRS won’t challenge me.

The real estate attorney told me that there is no such “24 months” rule. It’s best to not move into the 1031 exchange property at all cause the purpose of 1031 exchange is to buy an investment property, not for my personal use. So even if I move in after 2 years or 5 years, IRS will challenge me if I get audited. And unless I have a very good convincing reason ie like I lost my job, I will be asked pay the tax on the capital gain.

Does anyone know who is right?  I'm willing to wait until 2 years is over if "safe harbor" is true but if there is no such thing, I might just consider moving in there now and hope that I don't get audited.   

Thanks for all your responses!

[Whitney Nash]

With the information provided, I would advise my 1031 clients the same way your tax attorney advised you. Wait 24 months for the safe harbor. That said, keep in mind that in the event of an audit, a key consideration that the IRS uses when determining if a 1031 is valid is what the intention was when you purchased the property with 1031 funds. Was your intention to hold it for investment for a "period of time" (generally 2+ years)? And, was turning it into a personal residence something that only came up recently because of your job change that you weren't expecting at the time of purchase? If the answer to both questions are 'yes', it is my opinion that you should be OK to move in after the 24 month mark. There are additional considerations as to tax that could be owed when you decide to sell the property after it being a rental and personal residence, but that will depend on the timing of things, how long you live in it, etc. and is another conversation.