1031 Exchange Equivalent from investment properties into primary residence

[Kim Tran]

Hi everyone,

I am a new member of BiggerPockets and am eager to learn from everyone! My husband and I own a rental property and a primary residence. We are looking to buy a bigger primary residence to start a family. We would like to turn our current primary residence into a rental investment and 1031 exchange for our current rental property to help with buying a new primary residence. 

From our understanding, the 1031 exchange only works to exchange from 1 investment property into another. Is there an equivalent where we can sell our investment property to purchase a primary residence and defer the capital gains tax? 

Thank you so much! Appreciate all your help!

[Jackson Hanssen]

No. To take advantage you have to sell an investment or business property and buy an investment or business property.

In theory you can 1031 your old rental property into a newer and nicer investment property that you eventually make into your personal residence. However, that would take a year or two in order to not be voided as exchanging investment real property for personal property. 

Depending on the built in gain and how long you've lived there, you should be able to sell your current primary tax-free and roll any gains from that into your new primary residence, that is IRC section 121.

[Kim Tran]

Jackson - Awesome! That perfectly answers my questions. Thank you so much for your help! 

[Jackson Hanssen]

Absolutely, happy to help however I can

[Alex Olson]

You can exchange 1 property into multiple properties in locations and any asset class (farm, office, single family, multifamily). 

[Dave Foster]

@Kim Tran Yea like what @Jackson Hanssen Is saying here, you can only 1031 investment property for investment property, and later down the line convert it to your primary residence.

If you have lived in the property for two out of the previous five years you could qualify for the 121 exclusion, where you get the first $250k ($500k if married) of the gain tax free.

Say you lived in the property for two years and rented it out for three, you would still qualify for the full 121 exclusion. But in the meantime you could move into your new primary residence converting it from your 1031 replacement from the sale of your current investment.

This would be a great strategy. It just takes a little time.

[Gino Barbaro]

@Kim Tran

I would reach out to @Dave Foster for anything to do with 1031s.

Gino

[Kim Tran]

thank you so much for all your help here! I appreciate you all :)

[Jasmine Vida]

Quote from @Jackson Hanssen:

No. To take advantage you have to sell an investment or business property and buy an investment or business property.

In theory you can 1031 your old rental property into a newer and nicer investment property that you eventually make into your personal residence. However, that would take a year or two in order to not be voided as exchanging investment real property for personal property. 

Depending on the built in gain and how long you've lived there, you should be able to sell your current primary tax-free and roll any gains from that into your new primary residence, that is IRC section 121.

Is there a set amount of time before you can move into the rental as your primary? I am looking to sell an investment property and 1031 to a new investment property and would eventually move into that as my primary, but I haven’t been able to find any info on how long the rental would have to be a rental before turning it into our primary. I am also in Florida and qualify for the homestead exemption, is that double dipping on the taxes or are they different since the homestead is property tax and the 1031 is capital gains tax?  

[Jackson Hanssen]

@Jasmine Vida

It's hard to say, there is no hard and fast rule. Generally 1 to 2 years is where I've seen the bar drawn historically. A big thing the IRS looks at is intent, and renting it out for at least a year shows that you intended to use that property for investment.

Homestead exemptions are for property tax and 1031 is cap gains/income. Different things so no big cross over, but you won't be able to claim the homestead exemption while you're renting it out, because it won't be you who is living there. Though I don't see an issue to claiming the homestead exemption later on down the line.

[Ashish Acharya]

@Kim Tran There isn’t a direct equivalent to a 1031 exchange for selling an investment property to purchase a primary residence, as 1031 exchanges are strictly for like-kind investment properties. However, you could convert the rental property into your primary residence, live there for at least two years, and qualify for the Section 121 exclusion to avoid up to $250K (single) or $500K (married) in capital gains, though depreciation recapture remains taxable. Alternatively, consider a cash-out refinance to access equity without triggering capital gains or explore a 1031 exchange to defer taxes by purchasing another investment property.

This post does not create a CPA-Client relationship. The information contained in this post is not to be relied upon. Readers should seek professional advice.