Converting Property Under IRC Sections 121, 1031, and 1033 (2024)

It is often a question of what you want something to be, not necessarily what it is. TheIRS has provided different tax codesfor the disposition of different forms of property. If we look at real estate, for example,section 121 appliesto the sale of a primary residence,section 1031 applies to real propertyheld for investment and section 1033 that applies to property involuntarily converted—just to name a few. Each section contains positives and negatives. Each time you consider selling a property, you should look at the opportunities each may offer you.

Typically speaking, advanced planning oftentimes allows one to minimize tax consequences through the use of one or more tax sections. The IRS realizes that a person’s circ*mstances may change; therefore, it is okay for property to change in character overtime. This means an investment property can eventually become a primary residence,a vacation homean investment property, a primary residence an investment property, and so forth.

There may be a few additional rules when property is converted. Consider the following opportunities.

Exchanging From One Investment Property into Another That May at a Future Date Become a Primary Residence

The government has acknowledged the possibility of this scenario by creating a special rule that applies specifically to it. When a property has beenacquired through a 1031 Exchangeand later converted to a primary residence, the owner faces a mandatory five-year hold period before having the ability to sell obtaining theSection 121 exclusion. The taxpayor still must satisfy the minimum two of five-year occupancy as primary residence.

Utilizing both Section 121 and Section 1031 When the Property Value Is Greater Than the Exclusion

Many taxpayers wonder what options they have when considering the disposition of a primary residence and the gains fall outside the $250k individual or $500k married exclusion limits. In 1997, when section 121 was installed, home prices were significantly lower than they are today and limits that once seemed reasonable, today fall short. One option the owner has is to move out of the primary residence and establish the property as an investment. After a reasonable seasoning period it is then possible to sell the investment home utilizing section 1031. In fact, if the investment properties sale happens in a time period that section 121 can still be applied, the government has allowed the application of both tax codes. This makes it possible to take the exclusion and to merely exchange the residual amount using section 1031.

APPLYING SECTION 1033 WHEN THE CITY WANTS TO ACQUIRE A PROPERTY FROM YOU FOR FUTURE DEVELOPMENT.

It is possible for the city to acquire property you have held for investment, allowing you the opportunity toutilize a 1031 Exchange. Or, it may be possible for the city to acquire the property through involuntary conversion, allowing you to utilize Section 1033.While Section 1031 may offer greater flexibility of like-kind requirements, section 1033 offers benefits in time requirements and allows receipt of sales proceeds.

As you can see, it is often not the question of what something is, it is a question of what you want it to be. When considering the disposition of an asset, it is critical you consult appropriate tax counsel to review your opportunities. Equity Advantage is here to work with your tax and legal team. Call us for a brief review of the opportunities that may be available to you.

Converting Property Under IRC Sections 121, 1031, and 1033 (1)

Converting Property Under IRC Sections 121, 1031, and 1033 (2024)

FAQs

What is the difference between a 1031 exchange and a 1033 exchange? ›

While a 1031 exchange requires the purchase of a replacement property that is considered “like-kind” to the relinquished property, a 1033 exchange requires the purchase of a replacement property that is “similar or related in service or use” to the lost property.

What are the IRS rules of converting a 1031 exchange to a primary residence? ›

Your personal use of the property, including occupancy, must not exceed either 14 days or 10% of the total number of days you rented out the property within 12 months. This exchange only applies to single-owner properties. Once the 24 months conclude, you can move into the property and declare it a primary residence.

Can you convert your personal residence to investment and then do a 1031? ›

One of the frequent questions we get is: “can I use my primary residence in a 1031 tax-deferred exchange?” Unfortunately, the IRS' short answer is a definite no. Your home is your home, and a 1031 exchange is used to defer the capital gains taxes due on an investment property.

Can you do a 1031 exchange without a qualified intermediary? ›

To have a valid 1031 exchange, a qualified intermediary (“QI”) must be assigned the seller's rights to proceeds under the contract and transfer the relinquished property on behalf of the seller, pursuant to an exchange agreement.

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