There are several basic rules of the road when it comes to 1031 exchanges.
It’s important to remember that partnership interests cannot be exchanged under section 1031 (generally speaking).
Many people want to cash out and take money off the table in a 1031 exchange. That triggers taxable boot and will invalidate the exchange.
And then there’s the issue of qualified use in a 1031 exchange.
Let’s imagine that you exchange your south Minneapolis apartment building and buy an oceanfront condo in Sarasota, FL. You then plan to rent out that property for a number of years. Your initial intent is to hold that property for investment or business purposes (even though your long-term intent may not be clear). How long should you wait before converting that property to personal use? The safest answer is the longer the better.
We have had clients who have moved into their replacement properties and subsequently been audited so this is something you need to be aware of as a possibility.
There are IRS authorities (private letter rulings) that seem to indicate that two years is the standard minimum period of time that you should hold a replacement property before converting to personal use. To be extra careful, it’s a good idea to go longer than that two year minimum if possible.
Consider This Hypothetical:
You move into your Sarasota oceanfront property and then a better property becomes available a few years later. You want to sell that Sarasota property as your principal residence and purchase the new property. There’s another code section (121) that deals with the proceeds from the sale of one’s personal residence. Can you take the full 121 exclusion ($500K if you’re married, $250K if you’re single) on a property that you 1031 exchanged into? You used to be able to do this, but the rules have changed. Now you only get a fraction of the exclusion amount based on the ratio of time you rented the property out and the time you occupied it as your home. Let’s say you rented the property out for two years and then occupied it for another three years. In that situation, you would only get three-fifths of the 121 exclusion. The other thing to be aware of is that you can’t do a 1031 exchange and then do a principal residence exclusion until you wait five years. Once you 1031 into the property you have to wait five years before you take a principal residence exclusion on that particular property. Additionally, the principal residence exclusion does not exclude gain from the recapture of depreciation.
Rather than selling your principal residence and not getting the full exclusion and having to recoup the depreciation, you could elect to continue deferring your capital gains taxes in a 1031 until you die. When you die, your heirs will receive your property with a stepped up basis to the fair market value at the time.
1031 Exchange Company in Minneapolis, MN
CPEC1031, LLC works with real estate investors across the United States on 1031 exchange transactions that help defer capital gains taxes. With more than two decades in the 1031 exchange industry, our qualified intermediaries have the detailed knowledge necessary to ensure your exchange satisfies all the requirements of section 1031 of the Internal Revenue Code. Get the help you need on your next 1031 transaction by contacting our team. You can find us at our primary office located in downtown Minneapolis. Note that we work with clients who own property all over the country.
Defer the tax. Maximize your gain.
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