Say you complete a 1031 Exchange; rent out the property for two years; occupy it for three; and then rent it for another year before selling. Our foremost concern is security of the exchange proceeds, as exemplified by our addition security measures. To use the 121 exclusion on the eventual sale of this primary residence, you must own it … 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. Multi-family property. This two-year period makes you eligible for section 121 capital gains tax exemption. However, a taxpayer selling a primary residence that has been converted into use as a rental property for a period of time prior to sale, or that has been used partially for business purposes, such as a home office or a duplex, half of which is rented, may be able to combine IRC §121 and §1031 to maximize deferral of capital gains tax. The Tax Code is Silent. Convert Rental Property into a Principal Residence (§1031 Converted to §121). Taxpayers who have acquired a rental property in a 1031 exchange can convert it into their primary residence. Here's why: If the owner has lived in the home 2 out of the last 5 years, he gets a $250k capital gains exclusion if single and a $500k capital gains exclusion if married. 7. 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. 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. The newly converted primary residence is also no longer reported on Schedule E on the taxpayer’s 1040 return, rather on Schedule A. There are numerous scenarios involving tax code §1031 and §121: 1. The QI will receive the portion of the sale proceeds for the business or investment portion and the QI will acquire like-kind replacement property pursuant to the §1031 exchange rules and requirements. 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. 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. Dexter converted his primary residence to a rental property. John and Mary decide, however, to convert their property to a rental. When sold after five years, your realized capital gains of $100,000 with $10,000 of that gain representing depreciation recapture. 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. Allocations and Restrictions Under the Housing Assistance Tax Act of 2008, The Housing Assistance Act of 2008 addressed many issues related to §121 exclusion of gain on the sale of a primary residence including the segregation of the time a residence is held into qualified and nonqualified holding periods. Kim wanted to know if she could move info her rental property without losing the tax deferred benefit of her 1031 property exchange. And always keep this in mind: rental real estate owners can avoid taxes indefinitely using Section 1031 exchanges (named after the applicable section of our beloved Internal Revenue Code). If the taxpayer sold the residence in 2013, after three years of primary residential use, only one year of rental, 2009, would be considered in the allocation for the non-qualified use. 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