How to use a 1031 exchange

[Patrick GRibbin]

Hello to the BP Universe. I have just started listening to the podcasts and have already learned a ton.

I was wondering if anyone could help me out on my question. My wife and I have a single family rental home in Atlanta I am going to do a 1031 exchange on. We live in Greenville, SC and want to take our home we life in now and convert it into a rental. Can the funds in a 1031 exchange be used to purchase a personal residence or only other investment properties since it comes from the sale of a previous investment property.

If anyone can help me out on this please let me know. It would greatly be appreciated. We are just starting to get serious about investing into real estate to provide a better future for us.

Thanks,

Patrick

[Dave Foster]

@Patrick GRibbin, The 1031 exchange is used for the sale and purchase of investment property.  You must have owned the property you are selling with the intent of holding it for productive use in business investment or trade (so your rental is fine).  The property you  purchase to complete the 1031 you must also have the intent to purchase for productive use in business investment or trade.  So two things - first of all any kind of investment property held with this intent is "like kind" for any other type of investment property held with the same intent.  It's not the type of property its the use that matters.  Second, you cannot buy your primary residence because you are not buying with the intent of holding for productive use.  You are buying with the intent of moving in.

@Account Closed, is correct you can convert a property from investment to primary.  However the time lines she lists are the requirements if you want to sell and take part of the profit tax free. This is not the timeline that satisfies intent so you can move in to  your former investment property.  While there is no statutory holding period, the IRS did issue a safe harbor for this conversion practice to demonstrate that intent in 2008-16.  If you've held the property for investment for two years you can safely  change your intent and use and move in.  Your property then becomes your primary residence and subject to the requirements of sec 121 to make at least part of the gain tax free.  There may be other ways to demonstrate your intent that allow you to convert at less than 2 years.  It's a case by case determination by you as to what you and your accounting professional feel comfortable with

Since your primary residence has been the product of a 1031 exchange then as Christina said you'll have to have owned it for 5 years, lived in it for two out of the five years prior to sale, you'll have to recapture depreciation and you'll only get to prorate the gain tax free for the time you actually resided there.  So if you rented it for 2 and then lived in it for 3 and sold it you could take 60% of the gain tax free.

Regarding debt - there is no requirement to carry equal debt on your replacement property. Debt is not the standard of the completion of your 1031. If you want to defer all tax you must purchase at least as much as your net sale (contract price minus normal closing costs) and you must use all of the net proceeds in the purchase or purchases.  Most folks don't have other sources of cash so in order to accomplish the two criteria above they find themselves having to take out similar debt.  But this is not a specific requirement.

You can allocate the proceeds however you want in the purchases.  You can add cash from other sources if you want to reduce the net debt at the end.  You can also purchase less than you sell or take cash out - in this instance of a partial exchange you will pay tax on the difference.