1031 Exchange FAQ - PERSONAL RESIDENCE

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Can I 1031 Exchange my personal residence?

We get this question weekly and considering the current state of the real estate market across the country, it is understandable. The purpose of the 1031 Exchange is to defer into the future the normal capital gains tax that one would pay on the gain they would realize from the sale of real estate. However, the section 1031 Exchange rules written by the IRS specifically say that the real estate must be of "like-kind" and must be real estate held for long-term investment purposes (such as Land) or real estate held for business use, such as a rental house.

Your personal residence is disqualified from 1031 Exchange because it is what the IRS considers as "Real Estate held for personal use". If you truly wish to 1031 Exchange the house you are living in, the best advice would be to move out and begin collecting rents for 2 tax periods. After which you can demonstrate to the IRS that your property is a business and thereby qualifies for 1031 Exchange.

Related Info: residence, personal, real, estate, house, business


What are the 1031 Exchange laws regarding turning a 1031 exchange property into a personal residence?

What you are asking can be tricky. The 1031 Exchange Replacement Property must be acquired and held as a rental or a property held for investment. You need to show that this is your intent. The code and regulations are silent regarding a specific holding period before your property can be reclassified as a personal residence. But we've seen that rulings and opinions point to a minimum of two tax periods before you can convert it to a personal residence.

Related Info: residence, personal, turning, regarding, laws, we've, reclassified, period, rulings


Can I 1031 Exchange my Rental Unit and apply any of the proceeds to my personal residence?

No. There are a couple of issues here. In order to qualify for 1031 Exchange treatment there MUST BE AN EXCHANGE of properties. This won't happen since you are the owner of the rental property and the personal residence. Also, usage of the proceeds must for a like-kind property. A personal residence is not a like-kind property and real estate held for personal use does not quality for 1031 Exchange Treatment.

Related Info: personal, residence, proceeds, apply, unit, rental, like-kind, treatment, quality, usage


Is it possible to 1031 Exchange my personal residence for a business-related property?

The IRS had written some very clear and concise rules regarding whether your personal residence would ever qualify for 1031 Exchange. We have seen several articles recently where some tax guru has worked up a strategy for making this happen. And there may be some circumstances where this might have worked. But the facts are and remain, your personal residence DOES NOT qualify for IRS 1031 Exchange. There are ways to convert your home into a rental but that will take at least 2 tax periods before your property could qualify. Check out our 1031 Exchange Knowledge base article regarding this situation at http://www.realtyexchangers.com/1031_Exchange_Information_Center/Topic_8_-_Exchanges_Involving_Primary_Residence.php#Renting_out_your_old_residence.

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How do I figure out depreciation recapture on my personal residence for a 1031 Exchange?

This is a tricky question because you ask about depreciation recapture but you want to know how it reflects your 1031 Exchange on your personal residence. We have a great article about depreciation recapture about it in our 1031 Exchange Knowledge Base and we also show you how to calculate this in our FREE Capital Gains Tax Estimator. But we need to visit the other portion of this question about how depreciation recapture effects a 1031 exchange with your personal property. The most important aspect of this answer is that NO - you CANNOT 1031 Exchange your personal residence because your home is NOT considered like-kind property and will not qualify for tax deferred exchange. Do not attempt this, your exchange will fail and you will be subject to the capital gains tax on your home. For information about the types of property that do qualify for 1031 Exchange treatment, visit http://www.realtyexchangers.com/1031_Exchange_Information_Center/Topic_2_-_Qualified_Property.php#The Four Classifications of Real Estate.

Related Info: residence, personal, recapture, depreciation, figure, home, gains, qualify


Hi,I have three small rental properties (one duplex and two four units) in Minnesota that I would like to exchange for property on the island of Oahu, Hawaii. I'm wondering how realistic and possible this might be. I would also like to exchange my personal residence as well. Thanks, Bruce

The 1031 Exchange for property in Minnesota for property in Hawaii would work if both properties qualify for 1031 Exchange. However, your personal residence would not qualify for 1031 exchange.

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How do I use the personal residence exclusion in my 1031 Exchange taxes?

If you make more than one sale during the 2-year period and claimed the exclusion on your tax return, and sell another primary residence within the 2-year period, you cannot exclude the gain from the second sale. You must include the gain in your income. However, there are exceptions to this rule.

If you sold the residence and did not meet the ownership and use tests, you may exclude a reduced amount if you sold the residence due to:

A change in your place of employment.
Health.
Unforeseen circumstances to be determined by the IRS.

The amount of exclusion is the ratio of the number of months you owned and lived in the primary residence multiplied by 24 months. For example, if you owned and lived in the property for 12 months, your ratio would be 12 months/24-months or 50 percent.

Related Info: taxes, exclusion, residence, personal, months, exclude, lived, owned, sale


In a 1031 Exchange, how do you define a personal residence?

Section 1031 Exchange and the related regulations make it very clear that real estate held for personal use cannot qualify for 1031 exchange treatment. But sometimes the residence gets involved in an exchange and it can get complicated.

The term primary residence refers to the place in which you principally reside. If you have more than one home, only your principal home qualifies as your primary residence.

Your primary residence includes the dwelling unit and the land it's located on. The land alone, however, is not a residence. If part of the land is sold, but not the dwelling unit, the land sold is not treated as the sale of a residence.

Related Info: residence, personal, define, land, primary, dwelling, home, includes


How do I figure out real estate interest for 1031 exchange?

Here is a “nutshell” approach to figuring out how each kind of real estate interest (excepting your personal residence) is classified for tax purposes and how each is treated on the tax return.

There are three major classifications of interest on the Federal individual income tax return. Each classification is subject to different rules. Because of this, great care must be given to determine the correct classification of each interest item. It’s the only way to figure what is deductible and where to deduct it.

1. Business interest

(a) Interest on rental income real estate
(b) Interest on business indebtedness

2. Investment interest

3. Personal interest

(a) Consumer interest
(b) Qualified residence interest.

Borrower's Cost of Getting Loan
Borrowers may incur substantial fees and charges when a mortgage loan is funded. These costs include legal fees, "points", appraisal fees, escrow fees, service charges, surveys, real estate commissions and title costs. These financing costs must be analyzed and divided into two categories:

1. Costs that do not qualify as interest.
2. Costs that do qualify as interest.

Costs That Do Not Qualify As Interest
Costs that do not qualify as interest are treated as lending service costs. If the mortgage was obtained to acquire real estate used in business or held for profit, the costs are deductible by amortizing them over the life of the loan. If the mortgage was obtained to acquire real estate held for personal use, lending service costs are not deductible.

Amortization of loan costs is always taken using the straight-line method. Amortization is continued until all costs are written-off or the loan is paid off or assumed. If there is a balance in the unamortized loan costs account, and the loan is paid off or assumed, the tax treatment of the balance depends on the classification of the property. In cases of rental income and other business property, the balance is deductible as an operating expense of the property.

For example, 10 years ago you bought an apartment house and paid loan costs of $20,000 to acquire the 25-year mortgage loan. You now sell the property as part of a 1031 exchange. During the last ten years you deducted your loan costs by amortizing them at the rate of $800 per year ($20,000/25 years). Your deduction totaled $8,000 for the ten years ($800 per year times 10 years). The unamortized balance of $12,000 is deductible at the time of the sale as an operating expense of the property. Do not take it as a selling expense of the property - if you do, you could lose the entire deduction.

Costs That Do Qualify as Interest
Costs that qualify as interest are treated as prepaid interest - capitalized and amortized straight-line over the life of the loan.

The term "points" is used to describe the interest charges you pay as a borrower to a lender when you take out a mortgage. Lenders have different names for points: loan origination fees, premium charges, etc. But what they call them doesn't matter. If the payment for any of these charges or points is for the use of money, it is interest.

Charges or points paid for the use of money are deductible as mortgage interest. They are treated as prepaid interest and subject to the prepaid interest rules. Amortization of points is figured using the straight-line method and is continued until the points are all written-off or the loan is paid off or assumed. For example, if you are charged $2,000 interest points for a 20-year loan, the $2,000 is considered prepaid interest. Under the prepaid interest rules, you must spread your interest deduction over the tax years in which it belongs. In other words, you can only deduct in each year the interest expense for that year. $2,000 prepaid interest for a 20-year loan must be deducted over 20 years at the rate of $100 per year.

If there is a balance in the unamortized points account, and the loan is paid off or assumed, the tax treatment of the balance depends on the classification of the property. For rental income and other business, the balance is deductible as an operating expense of the property. For your personal residence, the balance is deductible as qualified residence interest, if otherwise qualified.

An easy to determine what kind of interest you are dealing with is this simple rule:
Interest deductions follow the money. Just ask this question for each interest amount - where did the money I'm paying interest on go? That's where the deduction goes. For example, you borrow money to buy a computer for your business. The interest is business interest - that's where the borrowed money went. Here’s another familiar example. You borrow a hard-money second nd on one of your rental properties and use the money to buy a new personal automobile.

Is the interest deductible? If yes, where do you deduct it? If not, why not?
Just ask the question -where did the money go? Since the money was used to buy a personal asset, the interest is not deductible. Wait a minute, you say. I borrowed the money on my rental property. Why can’t I deduct it against my rental property as an operating expense on Schedule E? The collateral has nothing to do with the use of the money you borrow so don't let it get in your way. The test is: Where did the money go?


Loan proceeds used to acquire:. ->Interest is deducted as:
Rental Property......................................->Rental Expense
Investment Property.............................->Investment Interest
Personal residence..................................->Itemized deduction (if qualified)
Farm property........................................>Farm expense
Dealer property......................................>Business Expense

Related Info: interest, estate, real, figure, loan, costs, money, deductible, expense


My place of business is also my residence, can I do a 1031 Exchange?

This is what we call a property with two classifications; each classification is subject to a different set of tax rules. The business portion of the property qualifies for 1031 exchange treatment - the personal residence portion does not. However, the personal residence portion of the property qualifies for the Section 121 250K/500K exclusion on the sale of a personal residence.

The allocation of basis values between the business and the residence portions has already been made on the client's tax return when the business property was set up for depreciation and the allocation for interest and real estate tax deductions.

An exchange sounds like your best bet since the entire property would be exchanged - the business portion would qualify for 1031 treatment - and even though the residence portion is a part of the exchange, since it does not qualify for 1031 treatment, it's treated as a sale and qualifies for the Section 121 exclusion. It's like having your cake and eating it too!

Related Info: residence, business, portion, personal, treatment, qualifies


I would like to 1031 Exchange a duplex for a home with a rentable mother-in-law apartment in the basement. Can this be done?

Is the duplex a rental? If so, you could qualify the 1031 Exchange replacement property if it is rental property. Family rentals count under Section 280A. If the home (replacement property) is all used for a rental - no problem. However, if the client plans to occupy the new home and only rent out the basement, an allocation would have to be made between the personal residence portion and the rental portion. Your tax person should do this. This same logic also applies to the duplex.

Related Info: apartment, basement, mother-in-law, rentable, home, duplex, rental, portion, replacement, allocation


How do we separate a house from our 1031 Exchange Replacement Property?

If you are purchasing land through 1031 exchange for as your replacement property and the property includes a personal residence, you need to make an allocation of the substituted basis between the residence and the nominal land to be used as part of the residence and the remaining acreage to be held for investment .

Related Info: replacement, house, residence, land, remaining, nominal, acreage, investment


How do we separate a house, which we plan to live in, from our 1031 Exchange Replacement Property?

If you are purchasing land through 1031 exchange for as your replacement property and the property includes a personal residence, you need to make an allocation of the substituted basis between the residence and the nominal land to be used as part of the residence and the remaining acreage to be held for investment .

Related Info: replacement, live, plan, house, residence, land, remaining, nominal, acreage, investment


Can I 1031 Exchange real estate AND some stocks for other properties?

Yes, so long as the real estate qualifies for IRS 1031 Exchange. Just remember that money and unlike property received in the 1031 exchange is considered boot and is taxable. How do you figure out what the boot is? Consider:

The amount of money received plus
the fair market value of unlike property received.

Let's same you 1031 Exchange real estate for other real estate but you also receive $10,000 cash and some securities with a fair market value of $25,000. Total boot received by you is $35,000.

Other examples of unlike property received in real estate exchanges are gold, silver, foreign currency, airplanes, motor homes, precious stones and real estate to be used as your personal residence.

Related Info: properties, stocks, estate, real, boot, unlike, value, market


What is a 1031 Exchange, tax-deferred Exchange, like-kind Exchange, Real Estate Exchange, Starker Exchange?

These terms ALL describe a Federal Internal Revenue Service Section 1031 Exchange. Though the names are different, they each mean the same thing though each has a different origin, some dreamt up by a marketer others by different industries. Real Estate pros like to call them Real-Estate Exchanges. Tax Pros like to call them tax-deferred Exchanges and investment pros like to call them like-kind Exchanges. Starker Exchanges have their own history was the name for them before the IRS called them 1031 Exchanges.

So what is a 1031 Exchange?

To understand 1031 Exchange, you must look to its legislative design. Congress intended non-recognizable taxable gain or loss if the Replacement Property received is merely a continuation of your old property investment. To qualify, you must structure and complete your exchange transaction in accordance with the requirements of §1031. Your intent doesn't count — what you actually do is what determines if you qualify or not. However, if the transaction is ambiguous, the Courts may look to intent of the parties. See Step Transactions and Substance over Form Doctrines—for more discussion on this matter.

Section 1031 provides for nonrecognition of gain or loss if three conditions are met:

Only property held for investment or use in your trade or business qualifies for §1031 exchanges. Both the property exchanged by you and the property received by you must be qualified. Personal use property such as your personal residence does not qualify. Nor does “dealer” property.
The properties must be of like-kind. They do not have to be identical. This is a very broad definition. All qualified real estate is of like-kind with all other qualified real estate.
There must be an actual exchange of properties. There can be a transfer of money with the qualified property. This will not disqualify the exchange. Taxpayers lose most tax cases involving exchanges because their transaction fails to meet the requirements of §1031 for a reciprocal transfer of property.

Related Info: starker, estate, real, like-kind, tax-deferred, exchanges, qualify, different, transaction, investment


I bought a rental property 6 years ago with a 1031 Exchange. Will I have tax problems by converting it to my primary residence?

Excellent question. So long as you can prove that the property has been collecting rents for the past 2 tax periods, you should have no trouble converting your 1031 Exchange rental property into your personal residence. Just be aware that when you do this if you ever decide to sell the property as a 1031 Exchange, you'll need to convert the property into a rental again and be able to prove that you collected rents from it for 2 tax periods.

Related Info: primary, residence, converting, problems, rental, years, periods, rents, prove, aware, you'll


I bought a rental property 6 years ago with a 1031 Exchange. Will I have tax problems by converting it to my residence?

Excellent question. So long as you can prove that the property has been collecting rents for the 2 tax periods, you should have no trouble converting your 1031 Exchange rental property into your personal residence. Just be aware that when you do this if you ever decide to sell the property as a 1031 Exchange, you'll need to convert the property into a rental again and be able to prove that you collected rents from it for 2 tax periods

Related Info: converting, residence, problems, years, rental, bought, rents, periods, prove, aware, you'll


What is un-like 1031 Exchange exchange boot?

In a 1031 Exchange, sometimes among the qualified like-kind Real Estate that is being traded, other items are included with bargain. Items that are not like-kind are considered un-like which can include money, gold, silver, foreign currency, airplanes, motor homes, precious stones and real estate to be used as your personal residence.

All Money and unlike property received in the exchange is boot and is taxable. You can easily compute your boot this way:

Figure out the amount of money received plus the fair market value of unlike property received.

An example would be: You exchange real estate for other real estate plus you receive $10,000 cash and securities with a fair market value of $25,000. Total boot received by you is $35,000.

Related Info: boot, un-like, estate, real, money, market, fair


Does 1031 Exchange apply to selling my primary house?

There are 4 classifications  of Real Estate according to the IRS. The two that qualify for 1031 Exchange are real estate held for investment, usually land AND real estate held for use as a business, usually some sort of rental property. Your personal residence or primary residence or your second home are NOT qualified for the benefits of IRS 1031 Exchange. If you are selling the land around your home, there are opportunities under the mixed classification rules concerning 1031 Exchange. We recommend a discussion with your tax advisor to see if you qualify for this inclusion.

Related Info: house, primary, selling, apply, real, estate, land, residence, usually, home


Can I 1031 Exchange the acreage near my residence?

Real Estate Held for Investment is considered like-kind and qualifies for 1031 Exchange. Your personal residence is considered Real Estate Held for Personal Use and does NOT qualify for 1031 Exchange. The scenario you describe is what is called a Mixed Classification. If all or some of the property you want to sell does not qualify for §1031 treatment, a transfer of that property in an exchange transaction will be treated as a sale of that property and subject to Capital Gains Tax. However, the property that does qualify for 1031 Exchange and an attorney can help you carve out your Purchase and Sale Agreement to reflect this.

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Can you do a sec 1031 exchange with your second residence?

Your second residence is considered just like your first residence. It is classified as Real Estate held for personal use, which is NOT considered a like-kind property and thereby does NOT quality for 1031 Exchange treatment. If you treat your second residence as a vacation rental there is potential for getting 1031 Exchange treatment, though as usual, there are additional rules to follow. The best thing to do is read more about it. For additional information regarding 1031 Exchange and your personal residence, click here. If you want information about 1031 Exchange and a Vacation Rental, click here.

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What assets qualify for 1031 Exchange?

For 1031 Exchange the real estate you own is considered an asset that must be thoroughly vetted in order to determine if it qualifies for 1031 Exchange. Since we are dealing with IRS matters, you should know that there are 4 classifications of real estate of which only 2 qualify for 1031 Exchange. Your personal residence and the property you purchased for a "quick flip" does not qualify for 1031 Exchange. Your vacant land and your rental home does qualify for 1031 Exchange.

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Can farm land be exchanged for a lake home in a 1031 exchange?

The first condition that must be met in order to accomplish non-recognition of gain under 1031 Exchange is: The properties exchanged must qualify, and be of  like-kind.

What that means is the properties on both sides of the exchange, the one[s] you are selling and the one[s] you are buying must all be considered like-kind. Farm land qualifies for 1031 Exchange treatment. The lake home may or may not qualify for 1031 Exchange. This all depends on how the home is going to be used. If this home is going to become your personal residence or a second or third home, the answer is no. Your primary residence is not considered like-kind with farm land. However, if the lake home you are purchasing is a vacation property that collect rents or an out-and-out rental property that has collected at least 2 tax periods worth of rent, then the answer is yes, the lake home would be considered like-kind with the farm land. Best to discuss this at length with your tax advisor.

What to know all three conditions that must be met to execute a 1031 Exchange? Check out our article for additional reading on our sister blog, 1031 Exchange – Want one? Meet these conditions.

Related Info: home, lake, exchanged, land, farm, like-kind, conditions






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