Can You Use 1031 Exchange Primary Residence

Last updated on October 1, 2021

A 1031 exchange is used to buy and sell income-producing real estate and defer taxes. But what happens if you want to do a 1031 exchange on your primary residence?

While many investors think they can't use their own dwelling house in a 1031, you actually tin can when y'all use enough planning and structure the transaction correctly.

Here's how to perform a Section 1031 tax-deferred exchange using your primary residence.

How a 1031 Substitution works

IRC Section 1031 allows real estate investors to relinquish or sell i property and supercede it with another similar-kind property and defer the payment of any capital gains taxation that would commonly be due.

Bones rules of a traditional tax-deferred commutation are:

1. Relinquished and replacement property must be similar-kind
2. Real estate must be used for business or investment purposes
3. Replacement property must exist the same or greater value than the property relinquished
4. Kick – either in greenbacks or a cash-similar do good – can not be received by the investor
5. Proper name on the title on the replacement property must be the aforementioned equally on the relinquished property
6. Replacement belongings must be identified within 45 days of the closing of the sale of the relinquished belongings
7. Replacement property must be purchased within 180 days of the closing of the sale of the relinquished property

Usually the IRS does not permit yous to conduct a 1031 exchange with your primary residence. That's considering the home that you live in isn't beingness used as an investment property or beingness held for business purposes. Instead, your primary residence is used to provide shelter for your family unit.

However, there are some exceptions to this rule. IRC Section 121 of the Internal Revenue Code gives some situations where you can conduct a 1031 commutation using your primary residence.

Section 121 vs. Section 1031

Before we discuss in detail how to practice a 1031 exchange on your primary residence, allow's talk about two things yous can't exercise:

• Beginning, y'all can't simply decide that your principal residence is a rental belongings and immediately turn around and apply information technology as part of a 1031 exchange
• Second, you lot can't live in your firm and as well claim that it is a rental holding (unless you have a multi-family property, which we'll discuss in detail afterward in this article)

Now, let'southward review what you can practice to utilise your primary residence in a 1031, and just every bit importantly how to go about doing it.

How to utilise Section 121

Section 1031 gives you a tax deferral on the payment of capital gains tax, Section 121 gives you a tax exclusion on the auction of your primary residence.

To see the requirements of a Section 121 you must live in the primary residence for at to the lowest degree two out of the past five years.

What a Section 121 does

• Excludes taxation
• Property used as a primary residence for at least two of the last five years
• Fourth dimension used every bit a primary residence does not have to exist concurrent
• Exclusion of $250,000 of gain for unmarried filers and $500,000 of gain for married taxpayers filing jointly
• Section 121 may merely be used once every two years

What a Department 1031 does

• Defers tax
• Relinquished property and replacement holding must be similar-kind and held for business concern or investment purposes
• All sales proceeds must be reinvested in society for tax on uppercase gain to be deferred
• Kick (cash or a greenbacks-like benefit) received from the transaction is taxable as a uppercase gain
• All rules of the 1031 taxation-deferred substitution must be adhered to, including the 45-day identification menstruum and 180-day replacement period and use of a QI (qualified intermediary)
• No limit to the number of times a Department 1031 exchange may be used

Using Section 121 and Section 1031 together

• Section 1031: Taxation-deferred exchange used for like-kind real estate held for business or investment use
• Department 121: Tax exclusion applies to a primary residence where the property has been used as a main residence for at least 2 of the past five years
• Split treatment: Use part of the property as master residence and office of the holding as an investment, such as a multi-family property where one unit is owner-occupied and the other units are rented out
• Section 1031 first: Acquire the rental investment as a replacement property in a previous exchange, then subsequently used a Section 121 to convert into your primary residence
• Section 121 first: Convert your master residence into Section 1031 rental investment property

Converting a primary residence into a rental holding

Let'southward look at how to catechumen your chief residence into a rental holding, using a small 3-unit of measurement multi-family belongings and a unmarried-family unit house as examples.

Multi-family belongings

Auction of a triplex (3-unit of measurement property) where you are living in one unit and renting the other ii units out:

• One primary residence unit – use a Section 121 to convert to a 1031 rental unit
• 2 rental units – use a Section 1031

Single-family unit belongings

1. Use Section 121 to convert primary residence to a Department 1031
2. Conduct a Section 1031 tax-deferred substitution to relinquish the single-family house and replace it with another like-kind holding used for investment purposes.

Retrieve the rules:

• Must alive in the main residence for at least two of the concluding five years before converting
• Can exclude up to $250,000 in capital gains if filing unmarried and upward to $500,000 in capital gains if filing jointly
• Department 121 may only be conducted in one case every two years

Converting a rental holding into a primary residence

You tin can also practise the contrary transaction and turn a rental property you lot currently own into your primary residence. For case, mayhap y'all'd like to downsize and motion into a smaller home, or relocate to a secondary market place where the price of living is lower and the quality of life is better.

If yous already accept rental property that was the replacement property for a 1031 exchange y'all previously conducted that you'd now like to turn into your personal residence. Believe it or not, the IRS allows y'all to do that, besides.

Merely first, you lot accept to prove to the IRS that you lot're not trying to pull a fast 1. In other words, you demand to testify that your 'intent' when you lot caused the replacement holding (the property that is currently a rental) was to treat it as an investment property.

IRS Safe Harbor Test

The IRS has developed a safe harbor test for determining how long the rental property that you acquired as the replacement property with a previous 1031 revenue enhancement-deferred exchange must be held before you tin can turn it into your primary residence. If you don't pass the prophylactic harbor test, you run the risk of the prior 1031 substitution that y'all used to acquire the rental house being invalidated:

• Qualifying Period: Replacement holding must be held for at least 24 months after the exchange
• During each of the two 12-month periods in the qualifying period:

• Property must be rented to another person for at to the lowest degree xiv days at a fair market hire
• Personal utilise of the property may not exceed 14 days or 10% of the number of days the property was rented at fair market place value during the 12-calendar month menses, whichever is greater
• Family or relative can be the tenant provided that they are paying a off-white market place rent

Other ways to prove you lot had the correct intent

There are several ways to demonstrate that you had the right 'intent' when you bought the rental holding that y'all now want to turn into your new residence:

• Use the property as a rental holding with the rent at fair market place value for at least 12 months or more
• Do not occupy the rental holding after y'all acquire it, especially right after the commutation
• Buy contract used to acquire the rental property as the replacement in your 1031 exchange should non exist contingent on the auction of your master residence
• Practise not renovate the rental property equally if you are going to movement in right abroad, although making normal renovations to utilize every bit a rental property are acceptable

Final thoughts

Single-family houses, multi-family property where you live in i unit and hire the other units out, and belongings y'all own and employ every bit a short-term rental such equally an Airbnb or HomeAway can all be used in a Section 1031 or Section 121.

You can use these 2 sections of the Internal Revenue Code to do a 1031 exchange on your primary residence, or to convert one of your current rental properties into your main residence.

The key factor to keep in heed is that you need to plough your primary residence into your former residence, and then continue with your 1031 revenue enhancement-deferred exchange to relinquish ane property and supersede it with another investment property.

Can You Use 1031 Exchange Primary Residence,

Source: https://learn.roofstock.com/blog/1031-exchange-primary-residence

Posted by: mirelesbobst1939.blogspot.com

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