An interesting and often asked question came up the other day. “How long must I hold an investment property before I can “safely” convert it to my primary residence?” The reason for that particular question is that the IRS treats these two scenarios differently.
IRS code 121 addresses the sale of a principle residence and can be summarized as follows: Capital gains tax is avoided if: 1.) The taxpayer has lived in the property for 2 of the past 5 years as his primary residence, 2.) The gain does not exceed $500,000 for a married couple or $250,000 for a single tax payer, 3.) The taxpayer has not filed an exemption under this rule within the last 2 years.
IRS code 1031 deals with real property held for investment purposes or real property used in trade or business. Basically, taxes can be avoided (really postponed) if the real property is exchanged for like-kind property. (qualifiers abound)
Getting back to the question at hand: What if a taxpayer exchanges an investment property into another property, then subsequently converts the acquired property into his primary residence? Can one use code section 1031 and 121 on the same property to avoid all capital gains taxes? Good question!
Unlike IRC 121, Section 1031 does not require a specific duration of ownership prior to an exchange; neither is there a minimum time a property must be held for investment purposes. The key qualifier in the 1031 language, however, has to do with “intent”. If the deal is engineered as presented above, the taxpayer would be very much in jeopardy, in my opinion. However, if the person’s circumstances change that cause a re-evaluation of the original intent, there doesn’t seem to be a problem with the IRS. How about a job change, divorce or the death of a spouse? And I’m sure there are countless other reasons.
So, if you are contemplating such a move, be careful! You must demonstrate a creative lack of planning! And, by all means consult your tax advisor.
Until next time,
The Apartment Broker
