Tax Guru – Ker$tetter Letter

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Converting Rental To Residence

Posted by taxguru on November 30, 2006

 

Q:

Subject: Exchange question

What is the test of intent in an exchange. Suppose someone exhanges an apartment rental building for a single family home, their true intent is to eventually turn the home into a personal residence.  They have told numerous people city building officials that their intent is to remodel the home for their use as a personal residence.  Before they purchased this replacement property, they arrange with the broker and seller of the property to convert the property to a rental in order to qualify as a rental property under 1031 rules.  This seems like a scam the IRS would frown upon.


A:

You are absolutely right that somebody who announces right up front the intention to personally occupy the home is setting himself up for serious problems with IRS accepting that property as proper like kind for a 1031 exchange

Conversion from a rental to personal use is allowed, but it has to appear that the decision to do so took place after the completion of the exchange.  I have long advised people who have a long-term goal of exchanging into a rental home and later on converting it to personal usage to keep that plan to themselves. The more they announce that intention to other people, the more damage they are doing to their case for a valid 1031.  Loose lips sink ships, etc.

As a tax practitioner, I always keep in mind the way in which everything would play out in real life.  Any audit by IRS of a 1031 exchange would normally be a few years after the actual exchange took place.  If the taxpayer is already occupying that home when the audit occurs, it will be a much tougher case to make that it was acquired with the intention of being for rental usage.  That wouldn’t be an impossible argument to win; but each bit of evidence the IRS auditor could find indicating prior intent to occupy it, the more difficult it would be.  Obviously, the more people who had been told of this previous intent, the more damaging the evidence against the validity of the 1031 exchange.

The moral of the story is that anyone stupid enough to be bragging around about his intention to only appear to be acquiring a rental property probably deserves to lose the tax savings from a 1031 exchange.

Thanks for writing.

Kerry Kerstetter

 

 

 

 

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