Combining Section 121 and 1031

[Tyler Prosser]

Hello,

My parents have a primary residence purchased for $45k. Recent comps in their neighborhood are in the $1 million range. Even with a exclusion of gain under Section 121 (MFJ: $500k), they are looking at over $100k in taxes from a sale. They are interested in turning the primary residence into a rental property for a couple of years and then performing a 1031 exchange.

I have read through Rev. Proc. 2005-14, which pertains to the joint application of Sections 121 and 1031 to the transaction of a single property that qualifies for both Sections. However, I'm unclear as to what the total fair market value of the replacement property need to be assuming a $1 million sales price and application of the 121 exclusion. Going to meet with a CPA but any input would be appreciated, thank you!

[Dave Foster]

@Tyler Prosser, Great strategy!!!  The easy way to look at this situation is that our parents will be selling an investment property and doing a 1031 exchange.  As part of that exchange they will be taking $500K in cash "boot".  Normally in a 1031 exchange that $500K would be taxable beause the IRS sees that as taking profit.  But because they qualify for the 121 exemption their account reconciles that with the taxable boot and not tax is due.

If their sale is for $1 mil and they take $500K out in boot then their reinvestment requirements becomes $500K because they already took $500K of profit out.

I'll reach out via pm to explain more fully.