Q-1:

Subject: Investment Property HARD & FAST RULE

 

Good Evening …..

I came across your website tonite while doing some searches for a real estate property question I have.   It is a question that I simply cannot find the answer to.

I apologize if you do not accept questions, but figured I would give it a shot….

The Big Question:

I own 2 condos. 

They are both rented.

I would like to buy a home and eventually live in it myself.  Right now I am living with and caring for a sick uncle.

I would prefer not to get hit with the Cap Gains Tax from selling investment property.

Could I sell the condos, buy the home, rent out the home  — so it is basically selling investment property to purchase another investment property.

Then, after a year or so, move into the home (after the tenants are gone)  —- would this allow me to avoid the Cap Gains Taxes ??

Thank you so much for your time and I would be deeply indebted for any help you could provide…..

A-1:

With 1031’s it’s investment property for investment property.  Not primary residence.  Here’s the link on my website that explains about primary residences.

First of all you need to get with your tax person to figure your best avenue.  If he/she suggests a 1031 you need a1031 accommodator to do your paperwork.  You CAN NOT do this yourself.  Your tax returns have to show your acquisition/purchase property as investment property.

If you decide a year or two down the road you don’t want to rent it out anymore, you can convert the acquisition/purchase property into a primary residence.

IRS can drop a deal if they feel your intent was to make the acquisition/purchase property a primary residence from the start & you’d have to pay the capital gains taxes.

Hope this helps.

Sherry Lee Kerstetter, President

Tax Free Exchange Corporation

Q-2:

Thank you Sherry Lee for your rapid response and information…
 
I guess what you’re saying is the IRS does not have a hard and fast rule when it comes to turning an investment property into the owner’s primary residence….??
 
I have to admit that surprises me.  So if a landlord were to decide he did not want to rent out his property anymore and moved in there is no way to know if the IRS will come looking for Cap Gains Taxes ?    What if the property had been rented for 10 years ?  Certainly the IRS would not say “we think this was your plan from the start and we want our $$”  or would they ?? 
 
I would think there would have to be some guidelines for this type of situation — no ???
  
Thanks again Sherry Lee and any more info would be greatly appreciated….   🙂

A-2:

The issue of converting a 1031 replacement property into a personal use residence has been a gray area for decades.  We in the tax practitioner community have been begging IRS for decades to give us a definite time period after which a conversion won’t be challenged.  IRS refuses to do so because they want to reserve the right to second guess anyone. 

There was a slight step in the direction of defining safe time periods in 2004, when our rulers in DC specifically required people living in converted 1031 property to own it for at least five full years prior to sale if they want to use the $250,000 per person tax free exclusion of gain, as I described in this blog post.

Obviously, the longer time that elapses between the exchange and the conversion to personal use, the less likely IRS will challenge it as pre-planned.  The cases that are most suspect are the conversions that occur in less than 12 months, as well as any that can be identified as preconceived.

They key is to have plenty of documentation of your intention to use the replacement property for rental, business or investment purposes.  Any plan to eventually convert it to personal use should be kept to yourself  If you blab that to a lot of people, there is a chance that one of them may be jealous of your 1031 tax savings and try to make trouble for you by telling IRS about your preconceived plans.  The culture of envy and hating anyone else who has more than you is widespread in this country.

I hope this helps.  You should also be working with a tax pro who understands these rules and they apply to real life people.

Good luck.

Kerry Kerstetter

Q-3:

Thank you Kerry and Sherry for the info and your expertise.

I can see how it can get very complicated….

I wonder , in your opinions, do you think if I purchase a home under the 1031 Replacement Property Rule, rent it out for 2 full years, and then moved in — would this be fairly safe from IRS suspicions ??

I get the feeling that every case is different in this situation and there are certainly no “definites” …

Thank you !!!

A-3:

We’ve been doing 1031’s all over the USA for over 25 years & IRS has never challenged a case from us.

There is no guarantees & the laws can change from now until then.

We can just advise you on what we know to date.

Good Luck.
Sherry