1031 Exchange rental into rental turned primary residence

[Jason Powell]

I have a 4 plex I've owned as a rental for 3 years. Cost basis 300k, value 600k. Can I 1031 exchange this into a nice $600k SFH that I rent out, and later on move into to as my primary residence?

How long would I have to rent out the SFH before moving in as to not throw off "red flags"? What would be new cost basis be when it becomes my primary residence, the original 300k or the new 600k purchase price? When I sell the primary residence many years from now, would all those gains be erased due to the 500k tax free exclusion, or would I merely be deferring them? Other questions I didn't ask?

Thank you to whoever answers!

[Dave Foster]

@Jason Powell, absolutely you can!!  And what a strategy to turn tax deferred into at least partially tax free!  

There is no statutory holding period.  The standard is long enough to demonstrate that your intent in purchasing the replacement property was to hold it for investment.  Here's the extremes:

1. If you sign the closing docs in the morning and the moving van with your stuff is in the driveway that afternoon  probably did not purchase it with the intent of using for investment.

2. There is a "safe harbor" given by the IRS at two years with some other caveats 

3. A lot of folks will feel comfortable at anything more than a year so that rental income is on two consecutive years.

4. Any other time length that you and you accountant feel comfortable with

When you finally do sell that new property you won't get 100% of the gain tax free but you can get close.  Once you have owned it for 5 years (because it was the product of a 1031) and have lived in it for 2 out of the 5 years prior to sale you can sell it and the following will apply.

1. You will prorate the gain between periods of qualified use (as your personal residence) and non-qualified use (as investment).  

2. You will get the proration for qualified use tax free.

3. You will have to recapture all depreciation.  

So, if you did the 1031 and used it for 2 years as a rental and then moved into it for 8 years you would get 80% of the gain tax free and have to recapture depreciation.

Not a bad plan at all!!!