You Can Do a 1031 Exchange on a Primary Residence—Here's How (2024)

FAQs

You Can Do a 1031 Exchange on a Primary Residence—Here's How? ›

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.

Generally speaking, your primary residence cannot be part of a 1031 exchange because it is not "held for productive use in a trade or business or for investment" per the IRC Section 1031 requirements.

Under IRC §1031, the following properties do not qualify for tax-deferred exchange treatment: Stock in trade or other property held primarily for sale (i.e. property held by a developer, “flipper” or other dealer) Securities or other evidences of indebtedness or interest. Stocks, bonds, or notes.

The taxpayer and the related party must hold the properties that each received as part of the 1031 Exchange transaction for a minimum of two (2) years. The two (2) year holding period starts running on the date of the transfer or conveyance of the last property involved in the 1031 Exchange related party transaction.

If you have a capital gain from the sale of your main home, you may qualify to exclude up to $250,000 of that gain from your income, or up to $500,000 of that gain if you file a joint return with your spouse. Publication 523, Selling Your Home provides rules and worksheets.

In February of 2008 the IRS established guidelines for determining whether a vacation home qualifies for a 1031 exchange. Although exchanges of second homes have been done for years we now have the definitive ability to say yes, they can qualify!

The two most common situations we encounter that are ineligible for exchange are the sale of a primary residence and “flippers.” Both are excluded for the same reason: In order to be eligible for a 1031 exchange, the relinquished property must have been held for productive in a trade or business or for investment.

A 1031 exchange must be completed within a 180-day period. This starts from the date of the sale of the relinquished property. If the exchange isn't completed within that time frame, it's considered invalid.

How long to avoid capital gains on primary residence? ›

How do I avoid the capital gains tax on real estate? If you have owned and occupied your property for at least 2 of the last 5 years, you can avoid paying capital gains taxes on the first $250,000 for single-filers and $500,000 for married people filing jointly.

Here's how it works: Taxpayers can claim a full capital gains tax exemption for their principal place of residence (PPOR). They also can claim this exemption for up to six years if they moved out of their PPOR and then rented it out.

You can sell your primary residence and be exempt from capital gains taxes on the first $250,000 if you are single and $500,000 if married filing jointly.

The extensions permit eligible persons who began an IRC §1031 exchange between July 12, 2022 and January 8, 2023, to extend the 180-day exchange period to the later of October 16, 2023 or 120 days after the original 180-day deadline date.

Typical DST Returns on a 1031 exchange investment could yield between 5%- 8% of monthly distributions based on your fractional interest.

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.

Long-term capital gains tax rates for the 2023 tax year

In 2023, individual filers won't pay any capital gains tax if their total taxable income is $44,625 or less. The rate jumps to 15 percent on capital gains, if their income is $44,626 to $492,300. Above that income level the rate climbs to 20 percent.

You don't have to pay capital gains tax until you sell your investment. The tax paid covers the amount of profit — the capital gain — you made between the purchase price and sale price of the stock, real estate or other asset.

The Revenue Procedure requires vacation property to be rented at least 14 overnights for each of two years preceding the 1031 exchange. Personal use must not be greater than 14 overnights in each of the two years or 10 percent of the number of days the property is rented at fair market rental per year.

Can you live in a 1031 exchange property after 2 years? ›

For this reason, it is possible for an investment property to eventually become a primary residence. If a property has been acquired through a 1031 Exchange and is later converted into a primary residence, it is necessary to hold the property for no less than five years or the sale will be fully taxable.

Incompatible: 1031 Exchanges and Flipping

This is because it doesn't meet the IRS like-kind exchange criteria of “held for trade or investment.” In most cases, real estate flipping focuses on quick resales, rather than longer-term holds.

The main benefit of carrying out a 1031 exchange rather than simply selling one property and buying another is the tax deferral. A 1031 exchange allows you to defer capital gains tax, thus freeing more capital for investment in the replacement property.

This 180 day period is the maximum time that the funds can be retained in the escrow account that the qualified intermediary has established for the exchange.

One key milestone within the 1031 Exchange timeline is the 180-Day Rule. Within the 180 days after closing on your relinquished investment property, you must close on the purchase of your replacement property. Get 1031 Properties will oversee the closing of your replacement property from start to finish.

Replacement Property Must be Same as What Was Identified.

The property acquired is substantially the same because what the taxpayer received was not different in nature or character from what was identified, and the taxpayer acquired 75% of the fair market value of the property identified.

Commercial property including rental properties, condominiums, shopping centers, strip malls, timberland, gas and water interests, and land represent real property eligible for a 1031 exchange. One of the popular examples of 1031 Exchange replacement properties include Delaware Statutory Trusts or DST properties.

Exchanges are written into the U.S. Tax Code and have been available to taxpayers in one form or another for almost 100 years. Exchanges have been available in their current structures since 1986 and are not a loophole or some “tax magic.” Exchanges are allowed as part of the rules!

Boot: If you have cash left over from the sale of the relinquished property after buying the replacement, the IRS considers the remainder earned capital gains and will tax you on it.

Once your 1031 exchange is complete, you are allowed to take out any remaining cash from the sale of your property. This money will be subject to capital gains tax.

What is the 2 out of 5 year rule? ›

The 2-out-of-five-year rule states that you must have both owned and lived in your home for a minimum of two out of the last five years before the date of sale. However, these two years don't have to be consecutive, and you don't have to live there on the date of the sale.

The proceeds from a home sale can be used in a variety of ways. With up to $500,000 available tax free, you could use the money to make a down payment on another home, pay down problematic debt, increase your stock portfolio or implement strategies to improve your retirement plan.

Report the sale or exchange of your main home on Form 8949, Sale and Other Dispositions of Capital Assets, if: You have a gain and do not qualify to exclude all of it, You have a gain and choose not to exclude it, or. You received a Form 1099-S.

Can you have two primary residence mortgages? No, you cannot legally have two primary residences. Even if you split your time equally between two places or in between places while relocating for work, the IRS requires you list one property as a primary residence while filing taxes.

You can exclude capital gains from the sale of a primary residence once every two years. If you want to claim the capital gains exclusion more than once, you'll have to meet the usage and ownership requirements at a different residence.

It is often possible to accomplish this goal by executing a 1031 exchange. The transaction is named for the relevant section of the Internal Revenue Code. It allows taxpayers to defer payment of capital gains if they reinvest profits from selling an investment property into a like-kind asset.

You can't avoid capital taxes by reinvesting in real estate. You can, however, defer your capital gains taxes by investing in similar real estate property.

If the gain is less than $250,000, an individual will not have to pay capital gains tax, and the same is true for sales less than $500,000 for married couples. This exemption only applies to home sales where it was your primary residence, not investment properties or second homes.

If the home you sell was in your name and was your primary residence for the two out of five years, you may not have to pay taxes on the full amount of your profits. It's called the “2 out of 5 year rule.” It lets you exclude capital gains up to $250,000 (up to $500,000 if filing jointly).

President Biden has released his proposed budget for 2024, which again looks to eliminate 1031 like-kind exchanges.

Will Biden end 1031 exchange? ›

Biden Budget Proposes End To 1031 Exchanges, Carried Interest Tax Break. President Joe Biden's proposal for the next federal budget includes a number of tax increases as well as a plan to eliminate two tax advantages for real estate: the 1031 exchange and the carried-interest tax break.

With an unlimited number of 1031 exchanges available, the IRS leaves it up to you as a taxpayer to qualify your intent. However, with the guidance of a Qualified Intermediary by your side and building out your case for intention, even unskilled taxpayers can succeed in their exchange transactions.

If the purchase of one of the properties fell through, the entire 1031 exchange will be disqualified because the exchanger did not acquire 95% of the fair market value identified (9/10 =90%). Of course, the result could be different in scenarios where some of the properties are more valuable than the others.

The taxpayer and the related party must hold the properties that each received as part of the 1031 Exchange transaction for a minimum of two (2) years. The two (2) year holding period starts running on the date of the transfer or conveyance of the last property involved in the 1031 Exchange related party transaction.

You can live in a 1031 property you acquired; it is your property. However, the IRS has implemented certain limitations that would justify all tax deferrals and exemptions provided by Section 1031, so you might not be able to move into your property immediately.

There is no limit on the number of times a 1031 Exchange can be completed. As a result, investors can theoretically defer capital gains taxes indefinitely, allowing their investment capital to grow tax free over a long period of time.

Typically the IRS excludes a 1031 exchange on a primary residence since it is not a commercial property. However, Section 121 of the Internal Revenue Code (IRC) provides some situations in which a 1031 exchange on a primary residence could be conducted. Here's how it works.

When a property has been acquired through a 1031 Exchange and later converted to a primary residence, the owner faces a mandatory five-year hold period before having the ability to sell obtaining the Section 121 exclusion. The taxpayor still must satisfy the minimum two of five-year occupancy as primary residence.

For tax purposes, you'll have to designate one of the homes as your primary residence, even if it's an arbitrary choice. Typically, you cannot finance both homes as primary residences simultaneously.

How long to reinvest capital gains from primary residence? ›

Gains must be reinvested within 180 days of the day they are recognized as taxable income. Step-up in basis: The longer you hold onto a property, the more you can increase the basis under which the fair market value of your property is calculated for tax purposes.

Did you know turning your primary residence into an investment property turns you into a rental real estate investor? As a new landlord, you can have a rental agreement, start charging fair market value rents—you may even be able to pay a part of your mortgage and receive some positive cash flow.

Long-term capital gains tax rates for the 2023 tax year

In 2023, individual filers won't pay any capital gains tax if their total taxable income is $44,625 or less. The rate jumps to 15 percent on capital gains, if their income is $44,626 to $492,300. Above that income level the rate climbs to 20 percent.

The only minimum required hold period in section 1031 is a “related party” exchange where the required hold is a minimum of two years.