1031 with a twist.....

[Brian Levredge]

I'm thinking about moving in a few years. I would like to sell a couple of my investment properties and 1031 into a new house. I would in turn rent this house out for a minimum of one year and a day at market rates and then occupy it myself. My first question is: does this trigger any kind of taxable event? If it does, are there different strategies to avoid it (ie: longer wait period, etc.)?

With that in mind I would want to take advantage of the 500k (I'm married) tax free gain on a primary residence based on the occupancy standards.

I've read about others doing this (not on BP) and was wondering if anyone has any experience or advice on this particular subject or if it's just out and out not possible

[Dave Toelkes]

Originally posted by Brian Levredge:

I've read about others doing this (not on BP) and was wondering if anyone has any experience or advice on this particular subject or if it's just out and out not possible

Your strategy is --

Relinquish several investment properties in a 1031 exchange in which you acquire one replacement property. Use the replacement property for a qualified investment use for a couple of years, then convert it to a primary residence. After at least five years of ownership, sell the property. As long as you and your spouse have occupied the property as a primary residence at least two of the five years prior to sale, take the maximum capital gain exclusion when married filing jointly,

Yes, can be done. Can you exclude $500K from taxes -- no, but you might get close.

Under the current tax code, the portion of time that you used the property as a rental is a period of non-qualified use for the capital gains exclusion. The maximum gain that can be excluded is reduced by the percentage of your ownership that the property was in service for a non-qualfied use.

Using the example above, the 1031 replacement property is used for a qualfied investment purpose for two years to establish the 1031 exchange. Then the property is converted to a primary residence, and occupied as such until sold at the end of five years of ownership.

Two of the five years are periods of non-qualfied use. Only 60% of your period of ownership counts as qualfied use, so only 60% of the maximum capital gain exclusion is allowed. In this example only $300K of capital gain can be excluded from taxes for a married couple filing jointly.

The longer you own the property and the longer you occupy as your primary residence improves the percentage of qualified use and therefore increases the allowed capital gain exclusion. You should note that to qualify for the capital gain exclusion for this property, you must own the property at least five years, and you must occupy the property as a primary residence at least two of the five years prior to the sale

You will still have to pay the tax on the unrecaptured depreciation you were allowed while the property was in service as a rental. Unrecaptured depreciation is never excluded from taxes, even for a primary residence.