1031 Property exit strategy

[Buddy Holmes]

We had a 1031 exchange property which was a new construction rental for about 14 months, then we used as a residence for two years. We sold it at just under 4 years with the idea of a residence sale after living in it for two years.  The letter of the law says live in 2 of 5 years.

Any room for using this exit?

[Dave Foster]

@Buddy Holmes, I don't want you to have an unpleasant surprise but I don't think you're going to qualify.  You mentioned that this property was the subject of a 1031 exchange.  That adds a couple different layers that were not mentioned.

1. Because the property was the product of a 1031 exchange you have to have owned it for at least 5 years.  That makes your plan a non-starter from the get go.

2. If you had owned it for 5 full years and lived in it for 2 out of a 5 year look back prior to sale then you could take the prorated amount tax free.  But another surprise that would get you if you don't watch out for it would be that you have to recapture all depreciation.  And this depreciation recapture would go all the way back to 2008 I believe.  So you'd have to go back to your original property and the depreciation you've taken on it.  And at a rate of 25% that might not be a small amount.

But because you didn't own it for the full 5 years prior to sale and it was the result of a 1031 exchange you're not going to be eligible for even the prorated amount.