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Converting a Rental to a Residence
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Volume #2004, Issue #09 |
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Some Taxpayers may be able to take advantage
of two tax code sections by first performing
an IRC §1031 exchange and later converting
the replacement property into a principal
residence which may qualify for tax benefits
under IRC §121.
Summary of IRC Section 121
Section 121 of the Internal Revenue Code allows:
- Exclusion up to $250,000
of the capital gain on a principal residence
for a single taxpayer and $500,000 for
a married couple filing jointly.
- The Taxpayer must own
and use the home as a principal residence
for two of the five years prior to the
sale. The ownership and use periods do
not need to be concurrent.
How Long Should the
House be Rented?
Section 1031 of the tax code does not provide
a defined "holding period" for investment
properties, but does specify that a taxpayer
must have "intent" to hold the property for
either investment or business purposes to
be considered a qualifying "like-kind" property.
The time period the property is held is only
one factor the IRS may look at to determine
the taxpayer's intent. Creating a paper trail
establishing the original intent to hold for
investment, along with reasons why the replacement
property was later converted to a principal
residence, would be beneficial to the taxpayer
in the event of an audit.
Two Perspectives on a "Holding Period"
Some legal and tax advisors recommend that
a taxpayer hold a §1031 exchange property
for a minimum of at least 12 months. The reason
for this is that a holding period of 12 or
more months results in the taxpayer reflecting
the property as an investment property in
two tax filing years. Another perspective
is holding the §1031 exchange property for
at least two years. In one private letter
ruling (PLR 8429039), the IRS stated that
a minimum holding period of two years was
sufficient. Although a private letter ruling
does not establish legal precedent for every
taxpayer, there are many legal and tax advisors
who believe two years in a conservative holding
period, provided no other significant factors
contradict the investment.
Cost Recovery/Depreciation
Capital Gains taxes must be paid on the cost
recovery ('depreciation") taken after May
6th, 1997 (at 25%), but may exclude additional
gain on the principal residence, up to a maximum
amount allowed by §121.
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NCS Exchange Professionals
5165 Johnson Dr., suite 100
Pleasanton, CA 94588
1-866-USE-1031
www.ncs1031.com
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