Able to live in a new 1031 property?

Question

I have a single property with two homes on it- I live in one and the other has consistently been rented for the past 6 years.  Their have been occasions when both houses were rented and I did not live in either.

If I sell it and would like to do a 1031 exchange, is it within 1031 rules to live at the new property if I will also be renting a portion of the property out, similar to my current arrangement?

Lastly, if I am able to live at the new property while planning to also rent a part out, would I be eligible for an 'owner occupied' mortgage rate if it is my primary residence?  Is their a huge disparity between owner occupied vs. investment property mortgage rate?

Thanks in advance!

Bill Exeter · Answer

@Henley H.,

This is what we refer to as a split use property where part of it is treated, accounted for and reported as your primary residence and part of it is treated, accounted for and reported as rental or investment property.

The portion that you live it would fall under Section 121 of the Internal Revenue Code.  You would qualify for the 121 Exclusion of $250,000 in tax-free gain if you have lived in the property for at least a total of 24 months out of the last 60 months.

The portion of the property that you rented would fall under Section 1031 of the Internal Revenue Code. You could structure a 1031 Exchange for the percentage/portion of the property that was truly held as rental or investment property.

You can certainly acquire one property that is also "split use property" where you live in one part of the property and rent the other part of the property. The critical component is that the percentage of the new property that you rent out must have a purchase price that is equal to or greater than the percentage of the sale price of your old property that was also held for rental or investment purposes. For example, if the old property was sold for $500,000, and 50% of the property was used as your primary residence and 50% of the property was held as rental property then at least $250,000 in purchase price/value in the new property must also be held as rental property.

Bill Exeter · Answer

Hi @Alisha Burgfeld,

Property acquired with the intent to hold for rental, investment or business use will qualify for 1031 Exchange treatment. Property acquired with the intent to rehab and then sell (i.e., flip) is not held for investment but rather held for sale (i.e., inventory in your real estate business) and would not qualify for 1031 Exchange treatment.

The critical element here is your ability to demonstrate that you did in fact have the intent to hold for rental, investment or business use should you be audited by the IRS or your state audit agency. Advisors often recommended holding period of 12 months, 12 months plus one day, 18 months or 24 months.

It is important to note that these are merely opinions of these advisors. The critical requirement is that you be able to demonstrate you had the intent to hold for rental purposes. The length of time that you hold the property for rental purposes can go a long way in helping you to demonstrate your intent to hold.

Alisha Burgfeld · Answer

Got it. Thank you @Dave Foster.

Dave Foster · Answer

@Alisha Burgfeld, no the banks really have nothing to do with it.  It is you and your accounting professional who decide if you qualify.  Once you decide to do a 1031 then it is the IRS who ultimately could decide differently.  But that is only upon audit.  They do not tell you yes or no ahead of time.

That's why its so important for you to be able to feel comfortable about your own intent at the beginning.

Alisha Burgfeld · Answer

@Dave Foster Thanks for the reply, that is good to know. Is it ultimately the banks that decide whether your "intent/hold time" was good enough and what qualifies?

Dave Foster · Answer

@Alisha Burgfeld, if your intent when you purchased the old property was primarily to resell it (a normal flip) then the 1031 would not be appropriate.  The 1031 exchange is used to sell that property you purchased with the intent of holding for productive use in business trade or for investment and then buying property you intend to hold for productive use.  The requirement is your intent and not the holding period.  But the length of time you do hold it is one way to demonstrate your intent.

Most folks feel that if you've owned a property for more than a year that is long enough to establish your intent to hold.  But there could always be specific circumstances where a hold time of less than a year might be appropriate.

Alisha Burgfeld · Answer

Hey guys this isn't entirely related, but it looked like you had some good advice for Henley, so I was wondering- can you do a 1031 exchange on a flip? i.e use the profit from the flip to purchase another flip/buy hold property? Thanks.

Henley H. · Answer

Thank you both for your help and these responses- really appreciate the information!

Dave Foster · Answer

@Henley H., If you've been accounting for the rental portion correctly and reporting it then your in great shape.

1. The portion you've lived in (for at least 2 out of the last 5 years??) would be eligible for the sec 121 primary residence exemption.  Whatever gain is attributed to that portion you can take the first $250K ($500K if married) in profit tax free.  No requirement to reinvest, no tax.

2. The portion you rent out could be 1031d into a new investment property completely tax deferred.

3. If you want a similar situation of two houses on one property then the value attached to the rental part of the new property must be at least as much as the rental portion of what you are selling in order to completely defer all tax.  If it is then yes, you could purchase the property using the 1031 and move into the other half immediately plus enjoy the tax free gain from the other sale.

Able to live in a new 1031 property?

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