1031 splitting from shared ownership

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1031 splitting from shared ownership

Jim Klapmust
Investor · Charlottesville, VA · Member since 2016 · 13 posts · 5 votes

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

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Dave FosterBusiness Member
Qualified Intermediary for 1031 Exchanges · St. Petersburg, FL · Member since 2013 · 9k+ posts · 9k+ votes
7y

@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.

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  • Chris Brown
    Professional · Stowe, VT · Member since 2017 · 15 posts · 13 votes
    7y

    Hello Jim,

    1.  Based on what has been said, I'm assuming that you and your bro own the property as tenants in common / joint tenants representing each of your 50% interests.  If so, the answer is yes.  You can sell the property, and each go your own way via 1031 exchange.   

    2.  Awhile = 24 months from the date of closing.  Then the investment property can be converted to a primary residence.  If, (and I'm stating this as an exchange professional not an accounting professional) you own this property as a primary residence for an additional 5 years (7 total), the taxes go away.  I would recommend consulting with your tax professional to confirm the additional 5 years of ownership.  

    @Dave Foster may be able to provide additional detail .

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  • Dave FosterBusiness Member
    Qualified Intermediary for 1031 Exchanges · St. Petersburg, FL · Member since 2013 · 9k+ posts · 9k+ votes
    7y

    @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.

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  • Jim Klapmust
    OP
    Investor · Charlottesville, VA · Member since 2016 · 13 posts · 5 votes
    7y

    @Dave Foster, @Chris Brown I really appreciate your posts.  Dave, I spent some additional time this weekend combing through all of your responses to other people's questions, so a double thanks.  I have a better understanding now, and I agree that the tax exclusion on the current primary makes for a better strategy to utilize the entirety of the tax benefit.  

    For kicks, does the following qualified use calculation work as follows:

    Purchased - 2004

    Lived in until 2007, converted to rental. *Tax law drew a line stating years prior to 2009 are considered qualified use, right?

    Hypothetically do a 1031 exchange in 2019

    Rent newly acquired property for 2 years (it's now 2021)

    Move into newly acquired property for 3 years (it's now 2024)

    2004-2008: 5 years qualified use

    2009-2019: 11 years rented

    2019-2021: 2 years renting (post 1031 exchange)

    2022-2024: 3 years used as primary 

    Does the prorating calculation go back to 2004 like this:

    8 years total qualified use of a total 21 years, 8/21= 38% allowed exclusion on gain (limits apply with 500k married exclusion limit)


    Or does the prorating calculation "reset" to the date of the 1031:

    3 years qualified use of a total 5 years, 3/5= 60%

    Say its $400k gain since 2004, so .38*400,000 = 152,000 sheltered.  Capital gains tax paid on remaining 248k.

    or... $400k *.60 = 240k sheltered, Capital gains tax paid on the remaining 160K.

    I get it that the longer you stay in the house as a primary, the percentage increases in either case.

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  • Dave FosterBusiness Member
    Qualified Intermediary for 1031 Exchanges · St. Petersburg, FL · Member since 2013 · 9k+ posts · 9k+ votes
    7y

    @Jim Klapmust, I believe that your use periods allocations only extend to the property you currently own and only count since 2009. Depreciation would be in effect for the years of ownership of the other properties and that's how they're accounted for.  @Ashish Acharya or @Natalie Kolodij could give you the for sure on that. 

    So I think your qualified/non-qualified use calendar will start with 2019 and the purchase of the 1031 property.  So if you rented it for 2 years and then lived in it for 3 years you would exempt 3/5ths of the gain up to the $250/500K limits.  In your example $240 sheltered $160 taxable.  But you have to know if any of that $440K total gain is depreciation because you owe all of that.

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  • Ashish AcharyaBusiness Member
    CPA, CFP®, PFS · FL · Member since 2017 · 5k+ posts · 3k+ votes
    7y
    Originally posted by @Dave Foster:

    @Jim Klapmust, I believe that your use periods allocations only extend to the property you currently own and only count since 2009. Depreciation would be in effect for the years of ownership of the other properties and that's how they're accounted for.  @Ashish Acharya or @Natalie Kolodij could give you the for sure on that. 

    So I think your qualified/non-qualified use calendar will start with 2019 and the purchase of the 1031 property.  So if you rented it for 2 years and then lived in it for 3 years you would exempt 3/5ths of the gain up to the $250/500K limits.  In your example $240 sheltered $160 taxable.  But you have to know if any of that $440K total gain is depreciation because you owe all of that.

     Thanks for the mention Dave.

    Jim, few things:

    1) Taxpayers cannot claim the Section 121 exclusion for a principal residence acquired in a like-kind exchange subject to the rules of IRC Sec. 1031 if the residence is sold during the five-year period after the date the residence was acquired.

    2) the non-qualified period before the exchange will tacked on to new one after the exchange. They dont just dissapear or reset. So, 8 years in your example is qualified use. 

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  • Matthew Ryan
    Developer · San Francisco, CA · Member since 2015 · 103 posts · 47 votes
    7y

    @Jim Klapmust - Keep in mind you can also invest your capital gain into a qualified opportunity zone investment. You have 180 days from the date of your capital gain (sale date) tp re-invest and if you keep that investment for ten years, you alleviate all capital gains on the appreciation. There is, of course, more details you should know beforehand but just want to throw that out there as an option.

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