Posted by William L Exeter on May 10, 2005 at 17:41:06:
Unfortunately, no. The only way to take advantage of the 1031 exchange is if the property had been held as rental or investment property. I would convert it to rental property and rent it for at least 12 months, probably a little bit longer since it was the primary residence, and then complete a 1031 exchange.
Question: 1031 exchange with 121 exclusion - Posted by Eileen
Posted by Eileen on April 28, 2005 at 12:10:26:
Hi all. I just discovered the advantage of combining the 1031 exchange with a 121 exclusion. I have a question on what part of the capital gains is tax-free in this particular scenario:
Say I bought an apartment years ago for $300,000. It is now worth $800,000. I made $500,000 in capital gains, but I tax-defer it into a 1031 exchange for 2 SFHs, each worth $400,000. To qualify for the 121 exclusion, I rent out one of the homes for 3 yrs and then live in it as my primary residence for 2 yrs. By this time the home is worth $600,000 and I decide to sell it. I’ve now made an additional $200,000 in capital gains.
Now my question is this: Does the $500,000 exclusion (for a married couple) in this scenario include both the $500,000 in capital gains from the relinquished property (apartment) PLUS the $200,000 from the primary resident home, or ONLY the $200,000 from the primary resident home? The difference is that in the first case, the $200,000 would be taxed since the $500,000 in capital gains from the apt has been excluded already, while in the second case, I would save in taxes on all gains.
If anybody knows the answer to this, please reply! Thanks a lot!
Re: Question: 1031 exchange with 121 exclusion - Posted by William L Exeter
Posted by William L Exeter on April 30, 2005 at 20:38:06:
There is a lot of misinformation circulating around in the press today regarding Section 121, Section 1031 and the combination of both, and it has confused many, many investors.
There are two scenarios under which a 121 exclusion can be used. So, let’s first discuss the two structures and the difference in requirements.
The first is when you buy property as your primary residence and hold it and live in it as your primary residence, or you have rental property that was NEVER part of a prior 1031 exchange that you convert into your primary residence. In these situations, the taxpayer must own and live in the property for at least 24 months out of the last 60 months in order to qualify for the 121 exclusion. The IRS uses what they call a 60 month look back. You would “look back” 60 months from the date the sale closed and determine whether or not you owned and lived in the property as your primary residence for at least 24 months during the 60 month “look back”. The 24 months does not have to be consecutive.
The second scenario is when you have rental property that WAS part of a prior 1031 exchange. This is the structure that applies to this case. The tax laws applicable to this structure changed on October 22, 2004 by the creation of a five (5) year holding/ownership requirement. The scenario - from start to finish - would go something like this. The taxpayer owns rental property - say a fourplex - and sells the fourplex and opens/begins a 1031 exchange. The taxpayer purchases two (2) SFRs as replacement properties within the 1031 exchange transaction. The taxpayer first must have the intent to hold the properties as rental or investment property in order to qualify for the 1031 exchange transaction. As you know, I typically recommend a 12 month holding requirement. In this case, I would be a little more conservative and hold the properties as rentals for at least 18 months. The taxpayer can then move into the properties after this rental period and convert the properties into his or her primary residence and then must live in the property for at least 24 months in order to qualify for the 121 exclusion. After the taxpayer has OWNED the property for FIVE (5) years, they would sell the property and take advantage of the 121 exclusion (which would only apply to the capital gain, not the depreciation recapture). To summarize, this second scenario requires three (3) things in order to comply with the new tax law and qualify for the 1031 and 121 exclusions: (1) HOLD the replacement property for 12 to 18 months or more as rental or investment property in order to qualify for the 1031 exchange; (2) LIVE in the property as your primary residence for at least 24 months in order to qualify for the 121 exclusion; and (3) OWN (not live) the property for at least five (5) years.
Note: the five (5) year holding requirement ONLY applies to properties that were ORIGINALLY acquired as part of the taxpayer’s 1031 exchange transaction. If the property was never acquired as part of a 1031 exchange, then there is NO five year holding requirement.
Now, going back to the original question. When you exchange into two replacement properties, the cost basis, capital gains and accummulated depreciation are all deferred into the two new replacement properties and are typically allocated on a prorata basis based on the market values. So, 1/2 of the capital gain of the relinquished property would be deferred into the second home and would be part of the 121 exclusion, and all of the capital gain directly attributable to the 2nd home after its acquisition would be part of the 121 exclusions. You would of course have to recognize your depreciation recapture allocated to this 2nd home.
Re: Question: 1031 exchange with 121 exclusion - Posted by EUGENE J. HUNNER
Posted by EUGENE J. HUNNER on May 10, 2005 at 16:00:49:
Single taxpayer has owned and occupied his personal residence for ten years. Fair Market Value is now 4,000,000. Cost basis is 1,800,000. If taxpayer sells, then gain recognition of 2,200,000, less IRC Section 121 exclusion of 250,000. Taxpayer could place residence to rental market, and possibly change his mind in a couple of years, then IRC Section 1031. Short of this scenario, can taxpayer somehow sell personal residence now, use IRC Section 1031 to xchange entire 4,000,000 into investment property, and recognize no gain currently? Eugene Hunner at 858 793-1606.