Use 1031 Exchange to purchase primary residence?

Question

Hi. First time posting in this discussion forum. Did some searching first and don't think I see this particular question asked before. I have an investment property in CT and a primary residence in FL (and a couple of other investment properties). I have been thinking about upgrading our primary residence in FL (owned by a family trust) but keeping our existing residence and turning into a rental property. I am also planning to sell our investment property in CT (owned by an LLC). Is it possible to use the 1031 exchange of my property in CT and sell my primary in FL to the LLC as the investment? This would mean that I could take the Cap Gains exclusion in the FL sale and the 1031 benefits in CT. I would sell myself the property using market value and immediately list it for rent. I do plan to keep the FL property as an investment for the foreseeable future. Also, the investment in CT is worth slightly less than the property in FL so from a $$ perspective that works out.

Thanks!

Whitney Nash · Answer

Hello @Patricia Andriolo-Bull

Unfortunately, you can not use 1031 exchange funds to purchase a primary residence or to purchase something that you already own (regardless if it's through an LLC or trust that you have ownership, control, etc. of). The replacement property must be new-to-you and both the relinquished and replacement properties must be held for investment or use in a trade or business for a period of time.

Regarding your primary residence in FL. If you have lived in it for at least 2 of the last 5 years, you can sell it and retain up to $250k (if single) or $500k (if married flinging joint) in gain without owing any tax on it because of the Section 121 exclusion. Any gain over those amounts would be taxable.

Carlos Ptriawan · Answer

Not related to original question, but back 10-12 years ago after the GFC 2008 crash and read carefully all the tax regulations and how real estate is appreciating, I come to the conclusion that if you have 1 mil buying power, it would be best to buy two 500k houses that's nearby rather than one 1 mil house bcause the rate of appreciation is doubled. Now after 10 years, the LTV to the original loan is reaching 75% and the equity of one home could  fully paid off one home, so I finished one 30YFRM in just 10 years. The next question is how do I strategize, the investment rental to primary conversion while satisfying the tax regulation, then it comes that solution to temporarily renting outside for one year.

Patricia Andriolo-Bull · Answer

Thanks!  This is the other option I was thinking of but didn’t want to wait to convert.  May have to unless I decide on something completely different.

Dave Foster · Answer

@Patricia Andriolo-Bull, What you're describing is called "basis shifting".  Because you and the LLC are probably related parties (if not even the same tax payer).  Specifically disallowed.  If, however the LLC had multiple members. And you (and your wife) don't own more than 50% of the LLC it would not be a related party and you could do the transaction as a 1031.

But even more than that - Something a lot of people will forget when counseling you is that putting your FL property into an LLC will void the homestead exemption.  That could cost you a bunch of money over the years.

@Carlos Ptriawan, gave you a great start to an answer that would totally avoid tax for you.  and put that $500K of profit from the primary sale in your pocket with no need to reinvest.  That is to do a 1031 exchange from CT to FL.  Buy a really really nice FL investment property (one that you would like to live in).  But don't move in immediately.  Rent it for a year or two.  And then move in and sell the FL property.  Changing the use of a property doesn't create a taxable event.  And the sale of FL will be tax free to the $500k limit under the primary residence sale rules.  Best of all that $500K doesn't have to be spent on another house if you don't want to.  Since you're moving into one of your former rentals.

Or you could convert the FL property to rental for another 2-3 years and then sell and still get the primary residence exemption.

And best of all - once you convert and move into the former investment you start converting a % of the gain every year from tax-deferred to tax free!!!

Dave Foster · Answer

@Carlos Ptriawan, That's sort of correct.  When you sell a primary under sec 121 the only requirement is that you have lived in the property for 2 out of the 5 years prior to selling.

To do a 1031 exchange the property you purchase must be purchased with the intent of holding for investment use.  So moving immediately into it would certainly not demonstrate that intent.  Using it for investment for 2 years and where you meet the safe harbor of rev proc 2008-16 is guaranteed to demonstrate your intent.

But there is no statutory holding period.  So it's a question of how long is needed?  A lot of folks think anything more than a year is fine.  there are also more aggressive folks who say only across two tax years or two calendar years.  It's all about your unique situation and what you feel good about demonstrating your intent before moving in.

Carlos Ptriawan · Answer

it's complicated and worthed the effort I guess, I started getting bidding war in our property :-)Maybe one question for you Dave without hijacking the thread, is I may wanna do 121 and 1031, the trick is I have to rent to third place within a year after selling primary+1031, if I have to move to the newly acquired 1031.

Carlos Ptriawan · Answer

yeah, in short, our plan of action:1. rehab primary2. sell and 121 primary3. rent a house4. rehab investment5. sell this rental6. 1031 to another house7. still rent a house8. move to the 1031 house after year or so.

interest rate is not a problem as we combine two proceed of house selling into one.

Patricia Andriolo-Bull · Answer

Thanks but are we talking about the same thing?  I'm looking to acquire a property I already own using the 1031 exchange of another property I own.  I would also be purchasing another primary residence since I am selling my existing one to be an investment property.

Carlos Ptriawan · Answer

I am doing similar, some key points:- you could move to your new 1031-acquired after the second year in general- you could combine sec 121 and sec 1031 in situation where you live in the house til 2021, and sell it in 2023.- when you do 1031, the position of that house should be still as your investment property so listed in schedule E- in case you want to minimize the tax, you could also move to that investment property, live there for two years, before got a prorated tax capital gain.

Use 1031 Exchange to purchase primary residence?

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