Emilio and Jimmy, thanks for your replies.
The duplex is a single tax item, no condo conversion and I pay one property tax. I hope you are right and I won't need to move next door in 2 years. In fact there is a fellow that wrote a book on duplex and multi-plex investments in the 1990's, I forgot his name. He claims exactly as you guys said, one only needs to live in the property for 2 of 5 years to get full exclusion. The law was changed in 2008?09? and a pro-rating is now required. The effect is you don't get 100% exclusion, depending on how long you owned the property. For me it is still a good deal since I owned it for 10 years.
In my research on this topic, I came upon a number of 1031 exchange websites that said it is not that simple:
===quote from property exchange====
"Clients owned a duplex in a beach community. They lived in one of the units and rented the other. Their retirement plans called for cashing out their large equity by selling the duplex. They planned to buy a large apartment house and operate it through a property manager, providing them a nice cash flow to supplement their other retirement income. Their retirement plans did not include buying another Primary Residence since they would be traveling for the next several years. Their financial objective was to accomplish all this maximizing their capital and minimizing their income tax costs. Their plan was really quite simple but you would be amazed at how many people would rush out and sell the duplex without any financial or tax planning.
Here’s the plan:
Enter into an exchange agreement with a Qualified Intermediary and sell the duplex as part of the exchange.
•The portion of the duplex used as a rental qualifies as Relinquished Property, the portion occupied as their Primary Residence does not. • The sale of the Primary Residence is a taxable event and reported on their tax return as such. • Gain on the sale of the Primary Residence qualifies for exclusion under §121—up to a half-million dollars for the married couple. • The proceeds from the sale of the rental portion of the duplex qualify as Relinquished Property under §1031 and since they are trading-up, no gain will be recognized at the time of the sale. • The clients can use their full before-tax equity in the rental portion as part of their payment towards the apartment complex they are buying. • The clients can use all or part of the cash proceeds from the sale of the portion of the duplex qualifying for §121 treatment. If their gain was more than $500,000 on this portion, the cash proceeds would be reduced by the capital gains tax on the excess amount. Since the clients will be investing a substantial cash payment into the apartment house, they will generate a positive cash flow from the rentals. • •
The same rules apply to sale of 4-plex etc. Just make the correct allocation between the primary residence (§121) and the rental portion (§1031)."
End of quote.
