1031 Exchange – Wolterman Law Office

Residential Property Exchanges

A 1031 exchange is a tax-deferred exchange of real estate properties that, under Internal Revenue Service (IRS) code 1031, allows investors to defer paying capital gains tax on the sale of a property by reinvesting the proceeds into another property. Primary residences do not typically qualify for a 1031 exchange since they are not commercial properties. Section 121 of the Internal Revenue Code (IRC), however, outlines situations in which a 1031 exchange on a primary residence is permitted.

Section 121 is not a tax deferral strategy like a 1031 exchange. Instead, it provides for a capital gains exclusion of up to $250,000 for individual tax filers and $500,000 for married couples filing joint tax returns who sell their primary residence where they lived for at least two out of the past five years. The exclusion can be used once every two years.

If the capital gains on the sale of the primary residence are below the exclusion limit, no capital gains taxes are owed, and a 1031 exchange would not be necessary. If the capital gains exceed the exclusion limit, a 1031 exchange cannot be used to defer the taxes. However, in certain scenarios, you can combine both Sections 121 and Section 1031 to maximize tax benefits.

Rental Property

Provided it meets the exchange requirements, you can convert your primary residence into a rental property and use a 1031 exchange to defer the tax liability on the sale. Requirements for a 1031 exchange property include:

  • Like-Kind Property: The property you sell and purchase must be considered “like-kind,” meaning they must be of the same character or nature.
  • Qualified Intermediary: You must use a qualified intermediary (QI) to facilitate the 1031 exchange process. The QI acts as a third-party intermediary and holds the proceeds from the property you sell to acquire the replacement property.
  • Investment and Business Property: Both the property you are selling and the property you are purchasing must be held for investment or used in a trade or business.
  • Identification and Acquisition Periods: You must identify the replacement property within 45 days of the relinquished property sale and acquire the replacement property within 180 days of the sale.
  • Equal or Greater Value: The replacement property’s value must be equal or greater than the sold property. Any cash received in the exchange is taxable and will be subject to capital gains taxes.

Vacation Home

Vacation homes are considered investment property if rented for at least part of the year. Homes rented for at least 14 days in each of the two years before the sale may qualify for 1031 exchanges. Rental income from the replacement property must be reported on your federal income tax return as rental income, and you must also hold the replacement property for investment purposes, not as a personal residence.

Partial Exchanges

Portions of a property used as a primary residence and a rental property may qualify for a 1031 exchange, provided it meets specific requirements. For property used as a primary residence and a rental property, the IRS requires you to allocate between personal use and rental use, and you can only exchange the rental portion of the property. The property must meet the following conditions:

  • The rental portion must be held for investment purposes and not rented or used as a vacation home or personal residence.
  • You must have owned the property for at least two years before the exchange.
  • You must have rented the property for at least 14 days per year or 10 percent of the days the property was used as a rental, whichever is greater.
  • You must follow the general requirements for 1031 exchanges, including using a QI, identifying replacement property within 45 days, and completing the exchange within 180 days.

The rules and requirements for personal property exchanges are more complex than those for real estate exchanges. The treatment of taxes on personal property exchanges also tends to vary, depending on the type of property and tax liabilities involved. For a more in-depth analysis of whether your property qualifies and what the benefits are to you, consult with one of our experienced QIs at 1031 Federal Exchange to discuss your options.

1031 Federal Exchange Helps Real Estate Investors Take Advantage of Tax-Deferred Exchanges

For comprehensive business, real estate, and tax services, call the QIs at 1031 Federal Exchange today at 513-488-1135 or contact us online to schedule a free consultation. Located in Loveland, Ohio, we serve clients nationwide.