1031 splitting from shared ownership

[Jim Klapmust]

Hi all,

Back in 2004, my brother and I acquired a rental property. We split it 50/50 and continue to this day. We aren't structured as a partnership or LLC, just two bros who bought a house together.

Fast forward to today, we are discussing an exit strategy, specifically tax deferment and going our separate ways. I’ve searched the web and forums here without luck so here are my questions:

1. If we sell the property and want to effectively end our co ownership, would we each do our own 1031 exchange? Or do we continue to have responsibility to purchase like kind property together?

2. After a 1031 exchange from and to a SFH rental property, can you hold the new investment for awhile and then convert it to your primary residence? If so, could you sell after two years of using it as your primary residence to get the tax shelter for capital gains on the sale of your primary?

Thanks all, I know I should probably consult a professional but wanted to get some initial feedback. Thanks in advance!

Jim

[Dave Foster]

@Jim Klapmust, From everything you're describing you and your bro own the property as 50% tic (tenants in common).  This means that you each own a piece of property that happens to be 50% of a larger piece.  when you sell you can each decide what you want to do with your 50%.  You can stay together as one 1031.  You can 1031 and he can take cash, you can each to a 1031 on just your half...  You've got great flexibility in how you proceed when you own as tenants in common.

Here's the deal on converting a property into your primary residence . You cannot use a 1031 to purchase a property you intend to use for your primary residence.  You must use the 1031 to purchase property you intend to use for investment purposes.  It is perfectly fine to change your initial intent and convert an investment property into your The key is what is your intent and how do you demonstrate that.  If you 1031 into a property and then move right in what was your intent?  To use as your primary.  If you 1031 into a property and then use it for rental for the next 24 months and do not use it for personal use more than 2 weeks or 10% of the number of days it is actually rented then the IRS gives you a safe harbor and will never challenge that your initial intent.  In Between 1 day and two years there is a wide range of time for you to decide if you've owned it long enough and treated it as investment enough that you can change your intent and move it.  An awful lot of folks feel good at anything more than a year.  But individual circumstances could allow a shorter (or longer) investment use period.

When you do convert the property into your primary residence you will then get the benefit of the primary residence exclusion like @Chris Brown said.  But it's not quite as good a deal.  When you move into a property that was the product of a 1031 exchange you have to own it for at least 5 years.  You must have lived in it for 2 out of the 5 years prior to sale.  And then you get to prorate the amount of gain between the period of "qualified use" (as a primary and tax free), and "non-qualified use" (as investment and you would pay tax on this portion).  You also have to recapture all depreciation.

The conversion into a primary is a slick trick and it can be very beneficial.  But it's greatest benefit is if you're able to sell the house you're living in now and take the full sale tax free and move into one of your investment properties and simply stay there for an extended time.  Every year increases the amount of tax free gain.