1031 Exchange to New Rental / New Residence Question

[Wayne Emminizer]

I have been trying to learn all I can about the different real estate strategies and I always like to have multiple exit strategies.  Completely understand in a 1031 exchange the new property needs to be a higher basis value than the one that was sold.  I also understand that the replacement property would need to be a rental as well to qualify.

My question comes with the replacement property and it's use.  If we performed this transaction and acquired a replacement property and had problems with tenants or problems with our primary residence or whatever and had the need or desire to stop renting it after X number of years and instead move into it what would the impact be for the 1031 exchange?  

If it would "violate" the exchange rules, who and how would the "governing body" know or inflict penalties?

[Dave Foster]

Nothing to clear up there @Bill B..  Well said.  @Wayne Emminizer, converting a property from investment to your primary residence  after x years is not prohibited after a 1031 exchange.  You just have to understand that your intent in purchasing the property in the 1031 must have been to hold for productive.  Your concern needs to be how to demonstrate that intent if ever asked.  

Here's the range - 

1. Do the 1031 complete the purchase and the next day your moving truck backs up to the door with your furniture.  What was your intent?  Obviously to purchase a primary residence - 1031 disallowed.

2. If you used the property for rental for 2 years at least 14 days each year.   Have not used it for personal use for more than 14 days or 10% of the number of days it was rented.  The IRS gives you a safe harbor and guarantees your intent.

3. Somewhere in between.  That's going to depend on the individual situation and what you're comfortable with documenting that your intent was to hold for investment use and then your intent changed.  As @Bill B. said a lot of folks feel comfortable at anything more than a year.

But there's a potential issue with your understanding of the first part of the process that could still trip you up.  While the basis of the old property does transfer into the new property that is not your reinvestment target.  If you want to defer all tax you must purchase at least as much as your net sale and use all of the net proceeds in the replacement.   If you only replace your basis in the new property you'll be pulling out your profit and that will generate a taxable event.