Has anyone had any experience with a client who received property as replacement property in a qualified 1031 exchange and now a number of years later is considering changing the replacement property from rental use to their primary residence. It was the client's intent at the time of exchange for this property to be rental property but now he would like to use it as his primary residence. This was an exchange between unrelated parties. My question is this, how long should the client wait after the date of receiving the rental property in the exchange before changing the status of the property from rental to primary residence. I cannot find anything specifically addressing these facts and circumstances in the Code or Regs or search engines for other sources. My gut feeling is that the waiting period should be about three to five years, but was hoping that the members of this board might have had a similar situation in the recent past. Would appreciate any input or opinions that anyone can contribute.........Happy Thanksgiving to all!
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recurring question
This is a recurring question because there is no specific answer. Let me respond on several levels.
1) The most fundamental economic fact is that the use of property should make sense from a business and personal point of view regardless of the tax effect. That is to say, if you need a government subsidy to make it work then you are headed in the wrong direction.
2) To qualify for 1031 treatment, the new property must be held for rental use at the time of the exchange. Purposes can change later due to external events including the passage of time. Two years is generally considered enough.
3) To qualify for Section 121, if that is the real plan, property received in a 1031 exchange must be owned for at least five years including the time used as a rental. -
Usage Irrelevant??
Folks, I'm over my head in this subject, but seems like there was some time ago a landmark Revenue Ruling which essentially maintained that a "like-kind" exchange be literally "like-kind" and not required to be "like-usage." The case in point involved several acres of land which was traded for several acres of land of appx equivalent value. Both were used as farmland prior to the swap, but after the swap one of the owners wanted to develop the land. RIA (I was a subscriber at the time) stated that this would also be true if the swap was made between residential housing where one of the new owners converted to commercial after zoning changes.
Has my information become outdated? This has been some time ago, early 90s I think.
Essentially, the ruling required that the "kind" of property be very similar, and didn't appear to be restrictive on future usage.Comment
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Usage is not irrelevant
Yeah, it's a terrible mish mash of terminology. They say "like kind" refers to the "nature or character" of the property as opposed to its "grade or quality." Things like buildings, zoning, and usage do not change the nature of real estate--it is still real estate. (To further confuse you I'll mention that the definition of real estate varies from state to state, and you have to go by that. The main example is mineral rights.)
But even for undisputably like-kind property with real estate on both sides of the exchange, usage is not irrelevant. My favorite explanation comes from the old Danny Santucci seminar. Section 1031 only applies to usage #1 and #4, although you can trade out of one and into the other:
"There are essentially five classifications of property for tax purposes:
(1) Property used in taxpayer's trade or business;
(2) Property held primarily for sale to customers;
(3) Property that is used as your principal residence;
(4) Property held for investment; and
(5) Property used as a vacation home."Comment
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