 Moving
into an investment property
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 Dear
Tax Talk,
If as a result of a divorce, I move into a house that was an investment property (rental) which was obtained in 2004 through a 1031 exchange, what taxes will I incur?
-- Jennifer
 Dear
Jennifer,
You would think you're doing something wrong, but you're not, at least not necessarily. There is no bright-line test that indicates when an exchanged property can be occupied by the owner without tax consequence. There are no provisions that would cause a current taxation situation, but rather you would have a problem with deferring the gain on the original exchange.
In order to enter into an exchange, you have to exchange
investment property for investment property. This is why the like-kind
exchange rules won't allow you to exchange a personal-use home,
such as a second residence, tax free. There are numerous tax cases
that have decided that the owner at the time of the exchange had
the intention of occupying the target property for personal purposes.
In disallowing the application of nonrecognition of gain treatment
to the exchange, the courts not only looked at the timing but also
the original intentions.
In your case, the necessities of the divorce are controlling and probably weren't anticipated at the time you entered into the exchange. Accordingly, the IRS will probably not challenge your 2004 nonrecognition of gain on the exchange.
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