He originally paid $320,000 for the property, the assessed value of the land was $40,000 and … I am interested in selling my rental property and converting my primary residence into a rental property. The §121 exclusion is reduced by a ratio of the time the property was used as a principal residence compared to the time the property was used in a business or investment. The taxpayer and their tax advisor must allocate the portion used as a principal residence for tax exclusion under §121 and the remaining farm/ranch portion qualifying for §1031 deferral; The taxpayer must have a QI in place for the §1031 exchange portion of the transaction (i.e. Split Treatment Transaction: Portion §121 (Residence) and a Portion §1031 (Used in a Business or Held for Investment), An Example: The Sale of a Four-Unit Property (Fourplex). You Can Do a 1031 Exchange on a Primary Residence—Here's How. API's Senior Exchange Counselors, attorneys and CPAs are available to discuss exchanges of any complexity-from standard delayed to improvement and reverse transactions. The property is sold to a buyer and the taxpayer receives the portion of the sale attributed to the principal residence portion (§121) and has a QI engaged to hold the net proceeds from the sale of the three rental units to proceed with a 1031 exchange into a like-kind replacement property. The rules for turning your primary residence into a rental, and making it eligible for both 1031 and 121 are fairly easy. Because the rental was a 1031 exchange replacement property before you moved into it, there are a couple of considerations you must remember: First, to get a pro-rated gain exclusion on the sale of a primary residence (more on that in a minute), you must own the rental for at least five years before you sell it. If you sold the residence in 2012 after two years of primary residential use, only the 2009 rental period would be considered in the allocation. You can’t live in your house at all while it’s a rental property, and you must actually rent it out for some period of time. […] Instead, it is used for gains exclusion on your primary residence when you decide to sell. In this scenario, the taxpayer is eligible for 5/8ths of the §121 tax exclusion since they lived in the property only five of the past eight years and the depreciation recapture during the three-year rental time period is not eligible for tax exclusion. If you later sell the hypothetical replacement property, now as your principal residence (IRC Section 121), you and your spouse may be able exclude up to $5 . By turning a rental into your primary residence, you can also benefit from both sections 1031 on primary residence and section 121. (To learn how a 1031 exchange works, click here.). Kim expected to rent out the property for five years then possibly move into it herself. A 1031 exchange can be a great way to defer taxes on the sale of an investment property. Convert a principal residence into rental property (§121 property converted into §1031 property); Allocations and Restrictions under the Housing Assistance Tax Act of 2008. We’ll have more on recapture in the next section. If you convert your primary residence into a rental property (i.e., you are, in fact, renting it to tenants who have possession, and you no longer personally occupy the property), you may use it in a 1031 exchange.Although the tax code doesn’t state exactly how long you must hold the property for rental purposes, most tax professionals agree that one to two years is long enough, provided you can demonstrate the property is used for business or investment purposes.The IRS is clear on two points: All right, so you’ve established that your property is no longer your primary residence, but a rental property. Thus, suppose the taxpayer had exchanged into the property in 2007, and rented it for three years until 2010,and then converted the property into a primary residence. He originally paid $320,000 for the property, the assessed value of the land was $40,000 and … After using a property acquired as replacement property in a 1031 exchange for business use or investment, you may convert the property to a personal use property. 1.1031(k) Treatment of Deferred Exchanges, What to do about Exchange Expenses in an Exchange. Many people ask about the possibility of converting a 1031 replacement property into a principal residence. The taxpayer must meet all the other requirements necessary for a §1031 exchange. To use the 121 exclusion on the eventual sale of this primary residence, you must own it … The replacement property was purchased on January 1, 2008 for $300,000. Kim wanted to know if she could move info her rental property without losing the tax deferred benefit of her 1031 property exchange. Section 121 allows for tax exclusion on the sale of a principal residence when the taxpayer lives in the property as their residence for two out of the past five years. After doing this, I would then purchase my new primary residence. Thornhill Securities, Inc. is a subsidiary of Realized. Section 1031 only provides for tax deferral as the original basis is carried over into the replacement property and capital gain taxes are owed when the replacement property is later sold and cash is received. Q: I have a rental house that my wife and I are planning to make my primary residence. Debt & Equity in the 1031 Exchange Let’s say that an exchanger sells a property for $300,000. This site is published for residents of the United States who are accredited investors only. As always, we recommend that you consult your tax advisor before proceeding. A Leading National IRC §1031 Exchange Qualified Intermediary. You buy investment property as part of a 1031 exchange (i.e., the replacement property) and hold it as investment or business-use property for at least 1 to 2 years up front, then convert the property into your primary residence. 4. In 1997, a revised Section 121 of the Internal Revenue Code, created a great opportunity for those who owned 1031 replacement property and wanted to convert it to a primary residence. The taxpayer can exclude capital gain taxes up to the threshold amounts of §121 ($250,000 single; $500,000 married) – and perform a §1031 tax-deferred exchange into a replacement property under §1031 which is to be held for investment or used in a business. Yes, taxpayers can still turn vacation homes into rental properties and do 1031 exchanges. Convert Rental Property into a Principal Residence (§1031 Converted to §121). 1031 Exchange & Primary Residence IRC Section 1031 and 121 The tax code provides a number of provisions that provide benefits to taxpayers who own real property. Likewise, you cannot sell an investment property to purchase a primary home with this rule. Ideally, the taxpayer should have facts/circumstances and documentation to support the intent to use in a business or hold for investment after the §1031 exchange. As long as you rent the property for two years and document its rental status, you will be eligible for the 1031 exchange on primary residence. Consider this scenario: what if you decide to turn your primary residence into a rental property? The Code states “no gain or loss shall be recognized on the exchange of property held for productive use in trade or business, or for investment, if such property is exchanged solely for property of like kind which is to be held for productive use in trade or business or for investment.” No ga… IRC Section 1031 allows for tax deferral on the sale of a property used in a trade or business or held for investment when exchanged for like-kind replacement property to be used in a trade or business or held for investment. Give us a call at 877-797-1031 or email us at firstname.lastname@example.org.This material is for general information and educational purposes only. 1031 Exchange & Primary Residence IRC Section 1031 and 121 The tax code provides a number of provisions that provide benefits to taxpayers who own real property. In some limited circumstances, converting a rental to a primary residence after the exchange has been completed may be allowed eliminating the majority of the gain via the $500,000/$250,000 exclusion. Depreciation Recapture. Section 121 tax exclusion must be allocated between the period of time the property was used as an investment property and the period of time the property was used as a principal residence. Question regarding 1031 exchange from primary residence to possible new rental property.I currently have a rental property and a primary residence in which I've lived for 6-years. 2005-14 when taxpayers converted a property from a primary residence to a business or investment use, or vice versa, taxpayers had to choose between IRC §121 and IRC §1031 treatment if both were available to them upon a sale. Five days after closing Kim was laid off her job of 15 years. In this scenario, the taxpayer must meet the requirements of §121 and have lived in the property for two out of the past five years before the taxpayer converts the principal residence into a rental property. The total ownership is eight years (which is over the minimum five-year holding period when converting a rental property into a principal residence.) Taxpayers who have acquired a rental property in a 1031 exchange can convert it into their primary residence. For example, in year three, after successfully meeting the parameter of Rev Proc 2008-16, the taxpayer may decide at such time to cease renting the property and convert the property to a primary residence or vacation home. When sold after five years, your realized capital gains of $100,000 with $10,000 of that gain representing depreciation recapture. One of the biggest questions we get is: “can I use my primary residence in a 1031 tax-deferred exchange?” Well, maybe not everyone, but certainly some. The tax code provides a number of provisions that provide benefits to taxpayers who own real property. After two years you converted it into your primary residence. You buy investment property as part of a 1031 exchange (i.e., the replacement property) and hold it as investment or business-use property for at least 1 to 2 years up front, then convert the property into your primary residence. A qualified holding period is defined as the following: In general, the allocation rules only apply to time periods prior to the conversion into a principal residence and not to time periods after the conversion out of a principal residence Accordingly, if a single taxpayer converts a principal residence into a rental property and never moves back in, and otherwise meets the two out of five-year requirement under §121, the taxpayer is eligible for the full $250,000 exclusion when the rental property is sold.