VA Househack 1031 Exchange w/ 121 Exemption

[Steven Embree II]

Here’s the skinny:

I am a veteran with a VA loan for a fourplex in which I reside in one of the units. I have lived here for three years, meeting the 2/5 year requirement for Section 121 Exemption. I am considering the sale of the property to partially fund the purchase of another fourplex (like kind).

There seems to be confusion with my lender on the following points:

1. I live on the property, so a 1031 Exchange may not apply. (I am not sure why it wouldn’t apply to the 75% of the property that is being used as investment property.)

2. The other units are investment property, so it wouldn’t qualify for Section 121 Exemption as that is only for a primary residence. (I am not sure why the 121 Exemption wouldn’t apply to the 25% of the property I live in.)

3. Moving away from the property may be an issue because, according to an underwriter, the VA requires primary residency for the property. (My understanding is that the VA only requires the property to be my primary residence for a year. I have been here three years.)

Am I in a no-man’s land where the tax gods can come and take money or is there some kind of special lamb’s blood I can paint over the four doors to get the IRS to pass by?

[Whitney Nash]

Hello @Steven Embree II

As far as doing a 1031 exchange goes, you and @Jeff Nash are correct in that the 25% used as your primary residence would qualify for the 121 exclusion and you can take that gain, up to the limit, tax fee to use for anything you want. The other 75% of the property would qualify for a 1031 exchange. You and your tax preparer would need to determine the amount attributable to the primary residence and the rest would be used in the exchange. As far as the VA loan on the current property goes and the possibility of being penalized for that, I'm not sure. I would get a second opinion from another lender or expert in that field. If you are worried about getting a VA loan for your next property and they require primary residence use only, then you may want to use the 25% of gain attributable to your current primary residence towards the purchase of your next primary residence. Then, use the 75% in the 1031 exchange towards a different property that will be held for investment and satisfy the 1031 rules for reinvestment.