we move into our 1031 exchange property?
I saw your article on Aug. 3, 2005, on avoiding capital gains taxes
with 1031 exchanges.
We successfully completed a 1031 exchange in December
2004. We are now renting out the new house, but would like to move
into this house when the lease is up. We think that we can sell
our current residence without capital gains taxes since we have
been living there for 22 years. However, can we legally move into
the new rental property without voiding the 1031 exchange done in
At least you thought to ask before you shot yourself
in the foot. In a Section 1031 exchange, you change one property
held for investment for another. The gain that you realize on the
exchange is deferred into the cost of the replacement property.
If you later sell the replacement property, you pay tax on the deferred
gain plus the appreciation in the replacement property. It's a good
deal because you can continually trade up for bigger property using
the equity in the relinquished property without paying income taxes.
If you change the use of the replacement property
into personal use, you run the risk of the Internal Revenue Service
disallowing the Section 1031 exchange. In your case, this would
mean that you would pay tax on the exchange in 2004 since you did
not trade for investment property.
Unfortunately, there is no safe harbor for determining
when you can convert the investment property to personal use without
running the risk of losing the exchange benefits. If the IRS interprets
your move as part of a preconceived plan, it could be several years
before you are safe. Since an examination is always done a couple
of years after you file your return, the IRS has plenty of hindsight
to detect a preconceived plan. I would say that to be fairly safe,
you're probably looking at a minimum of three years from the date
of the exchange.