1031 to Primary Residence

[Nima Rezvani]

Hi everyone, thank you all in advance for your help with this! I’ve got a bit of a weird tax question. I currently have an investment property that I’ll be trying to sell soon. All of the value would be considered long term capital gains and so I was trying to see if I could instead 1031 exchange the proceeds into an investment property which I’ll eventually move into and sell with the primary residence deduction.

My questions about this strategy is how long would the property need be classified as an investment property? Could I live in the place during this time if it’s rented to someone in the family and they allow me to live there? I believe I’d need to live there for at least 2 years and hold the property for 5 years but would like a confirmation if possible?

Thank you again for your assistance!!

[Dave Foster]

@Jake Andronico, thanks for that shout out.

@Nima Rezvani Yes you can 1031 from one investment property to another investment property and then later convert it from investment to your primary residence.

When you have then owned the property for at least 5 years and lived in it for at least 2 out of the 5 years immediately prior to sale you can then sell it.  But you will not get the full primary residence exclusion

1. You will get a proration of the gain free according to the amount of time you lived in it versus the amount of time it was rented.  If you rent it for 2 years and live in it for 3years you get 3/5ths of the gain tax free.  Rent it for 2 years and live in it for 8 years

2. You still have to recapture depreciation. 

There is no statutory holding period before you convert an investment property to your primary residence.  However, when you do the 1031 you must have the intent of holding that property for investment use.  So how long do you have to wait???  Well if you back the moving truck up the day you close you will have a tough time proving that you bought it with the intent of holding for investment use.  If you wait two years and have only used it for limited personal use then the IRS guarantees your investment intent under Rev Proc 2008-16.  So the answer is somewhere in between 1 day and 2 years depending on how you can demonstrate your intent.

I doubt if there would be much of a benefit If you're actually living there but pretending to rent to a family member.  You'd have to charge, collect and report the actual rent.  And you'd have to maintain a primary residence of some sort somewhere.  The IRS knows where you're registered to vote and your kids go to school and you have your drivers license.  There's less gray ways of handling this.