1031 exchange to buy future primary home

[David Weymouth]

I have sf rentals that have done quite well. I live out of state in a home that is larger than my wife and I need. We like the area and don't plan to move were the rentals are located. As I mentioned they exceeded my expectations and there will be considerable regular capital gains along with the recapture of the depreciation %25 tax. My question is if I have found a home near me that is a better fit for retirement could I do a 1031 exchange with one of my rentals and buy this other home and continue renting out it for a year or 2. Then sell my larger primary home and move into the rental and make that my new primary home. My thought pattern is that I would not have to pay any capital gains using the 1031. I hope this post makes sense and someone has the answer!

[Dave Foster]

@David Weymouth, With enough runway you can absolutely turn a 1031 into a primary residence.  A 1031 exchange must involve initially the sale of investment real estate and the purchase of investment real estate (and it can be any type and anywhere in the US or a couple of territories.  So, yes you can exchange between AZ and WA).  But you never have to keep the  use as investment forever.  Only long enough to establish that it was your intent to hold for investment. use.  

There is no statutory holding period.  There is a safe harbor from the IRS in Rev Proc 2008-16 at 2 years under a set of circumstances.  Many people feel comfortable at more than a year.  But the true standard is - long enough to establish your intent to hold for investment.

So your game plan is solid.  Sell in AZ.  Do a 1031 and buy in WA.  Use WA for investment for a year or two and then convert the property to your primary residence.  Changing the use of a property does not create a taxable event.  And you're using deferred tax to help buy your retirement home.  

A good plan we've had many clients execute over the years.