Make Sure You Understand the New Rules!
Section 1031 is a valuable tax tool for the real estate investor’s toolbox. Prior to recent rulings, an investor could purchase an investment property, rent it out for a few years, and then convert the property to their primary home. Should they decide to sell it after the 5 year minimum holding period, they could claim the maximum allowed primary home exclusion under Section 121 ($250K for single and $500K for married couples). With a little careful planning, taxpayers were able to eliminate up to $500K in gain, and the 1031 exchange was only a distant memory. Those were the good old days.
Fast forward to present day. Thanks to the Housing Assistance Tax Act of 2008, a change was imposed which indicated that the gain for any period of non-qualified use starting January 1, 2009 would not be excluded. The good news is you can still convert your 1031 property to your primary home. The bad news is that there is no longer the possibility of utilizing the maximum exclusion. Here is a breakdown of the new rules:
There is a 5 year holding period if you plan to eventually sell the property as your primary home.
When you sell the property, the gain is prorated between time you held it as investment and when it was your primary home. For example, let’s say you owned a property for 6 years, and rented it for 2, and the total gain is $300,000.00. 1/3 of the gain, or $100,000.00, would be taxable and 2/3 would be excluded.
The longer you live on the property, the better it will be for you should you ever decide to sell the property. Whatever you do, if you move onto the property, make sure you hold it for the full 5 years. If you sell it before the 5 year period is up, the entire gain is taxed! It will not qualify as personal residence or as a 1031 property if it was used as your personal residence at the time of the sale.
We cannot stress the importance of consulting your tax advisor when dealing with situations such as this where you are dealing with a property that was investment and personal residence. Knowing and understanding the rules beforehand can save you valuable time and tax dollars later.
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