The Housing Bill currently contains a little known change that could affect the way real estate investors combine a 1031 exchange with a 121 exclusion.  It all depends on how the final law is written or drafted, but the U.S. House of Representatives passed the Housing Bill this week and it has now been forwarded to the U.S. Senate for consideration. 

Here is the basic issue.  The current language contained within the Housing Bill as it was passed by the U.S. House of Representatives no longer allows a taxpayer to exclude gain from a sale of their primary residence for the time that the property was used for non-qualifying uses (i.e. rental, investment, use in a business, etc.).

This means that if the taxpayer had acquired his or her primary residence through a 1031 exchange as investment property and then subsequently converted the property into his or her primary residence, the gain that was deferred from the 1031 exchange could not be excluded under Section 121, and the amount of gain for the period of time the new property was held for investment would also not be excluded. 

If the property was held as investment property for 2 out of 5 years then 2/5 of the gain would not qualify for exclusion. 

The U.S. Senate has to pass it and then the President must sign it, so a lot can change between now and then.  

We will keep you updated.