REAL LIFE QUESTION AND ANSWERS

Today, I received a question from a reader of my blog. It is a very common question, so I thought I'd give you both the actual question and my answer. All identifying information has been removed. Click here for more formal information regarding converting a rental to a residence.

Dear Lisa:

After reading your column a question has come up no one seems to know the answer to.

We made a 1031 exchange from rental for rental . do you know how long we must rent it out for before we can move into it as a principle residence? So far it has been 14 months.

Much appreciate your opinion here.

My Response to the Question is Below:

Dear Client:

The answer below is general and cannot substitute for the guidance of your individual tax advisor. It does not constitute tax or legal advice. You are strongly encouraged to seek the advice of your own tax advisor prior to making a decision.

Here's My Answer:

The reason that no one can give you a specific time frame is because until recently, the IRS has not given any specific guidance regarding how time affects whether the property will qualify as investment property under section 1031. The main guidance has been that the taxpayer must substantiate that he/she intended to hold the property for "productive use in a trade or business or for investment." Time is only one of the factors in determining intent. Different tax advisors have interpreted the time factor in different ways depending on how aggressive their approach.

Many tax advisors are recommending a full 24 months of investment use prior to converting the property to personal use. This approach seems to be supported by the recent Revenue Procedure 2008-16 regarding vacation homes, which requires a full 24 months of investment use with very limited personal use (14 days per 12 month period or 10% of the time it was rented).

You have a couple factors supporting your investment intent: 1) your relinquished property was a rental; 2) your replacement property is a rental (although, you do not mention whether it is currently rented), the more rental history and rental income you report the better you will be able to substantiate your investment intent.

Your tax advisor should have been instructed to put the current rental property on a depreciation schedule (and take it off when you convert it to personal use), so there is a clear demarcation of converting its use.

Be aware that if you want to eventually sell this property as your primary residence and qualify for the section 121 exclusion ($250K for single or $500K for married filing jointly) you will need to live in it for two out of the last five years AND you will need to have OWNED it for a total of FIVE YEARS before qualifying for the exclusion.

I hope this answer was helpful in giving you some information about the subject. Please discuss this issue with your personal tax advisor because they will be able to review all aspects of your tax situation to make sure that all contingencies are covered.

Please feel free to send me any questions you may have regarding 1031 exchanges. If you have the question, most likely many others have the same question and would appreciate the information.

Lisa A. Lambert, Esq.  877.646.1031  or LisaL@apiexchange.com

Asset Preservation, Inc. 800.282.1031 or info@apiexchange.com  or www.apiexchange.com