The Ins-and-Outs of a 1031 Exchange
Ask the Real Estate Lawyer: Real Estate Law Q&A
REM #LAW 630
By Ilyce R. Glink and Samuel J. Tamkin
Summary: A reader wonders if they can use
a 1031 exchange but move into the home less than one year after the purchase.
Ilyce and Sam explain that the IRS has not set hard and fast rules as to how
long you have to keep the new property as income-producing. Some practitioners
say that if you change your mind after the sale and make it into your primary
residence you will be fine while others believe that the only safe route is
holding it for two years.
Q: In a 1031 tax-free exchange, can we use a medical release to move into a
house sooner than the one-year required rental time?
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My husband has become disabled and we need to move into the house that we purchased
in the exchange now rather than waiting for the one year rule to expire.
I can’t seem to get an answer from the exchange people or the real estate
A: A 1031 tax-free exchange is an exchange of one property for another like-kind
revenue-producing property. Section 1031 of the Internal Revenue Code provides
the rules that must be followed if you want to defer paying tax on the sale
of one business producing property when you buy another.
The purpose of a 1031 exchange is to permit the sale and purchase of investment
property without having to pay tax on the gains on the sale of the original
property. If you have owned a building for many years and want to sell it, you
can without paying taxes on the gains. But you must follow the strict rules
set up by the Internal Revenue Code and purchase a replacement property within
a certain number of days and the replacement property’s cost must be higher
than the sales price of the old property.
In a nutshell, you are selling one income producing property to buy another
income producing property. You are not allowed to use the 1031 exchange mechanism
when buying or selling your personal residences.
In your letter, you mentioned a one-year rule and must have been told by someone
that you have to keep the new property as an income-producing property for at
least one year.
Generally, the safest bet is to keep the property for two years. There are
a number of practitioners in the 1031 exchange area that will also tell you
that upon the purchase of the new property you must have had the intent to buy
it and keep it as a commercial property. They would claim that if your intent
changed after the sale, you would be ok.
Your husband’s disability surely is a hardship on you and your family,
but there is no provision in the 1031 exchange rules relating to this hardship.
If you move into the house that you purchased in the 1031 exchange and make
it your primary residence you run the risk that the IRS will disallow the 1031
exchange and have to pay tax on the gains. In your situation, you may not have
a choice and will have to take the risk.
Keep in mind that the IRS has not set hard and fast rules as to how long you
have to keep the new property as income-producing. Some practitioners say that
if you change your mind after the sale and make it into your primary residence
you will be fine while others believe that the only safe route is holding it
for two years.
For further details, please consult a tax attorney.
Samuel J. Tamkin is a Chicago-based real estate attorney. Ilyce
R. Glink’s latest book is 50 Simple Steps You Can Take To Sell Your
Home Faster and For More Money In Any Market. If you have questions for
them, write: Real Estate Matters Syndicate, PO Box 366, Glencoe, IL 60022
or contact them through Ilyce’s website www.thinkglink.com