If I acquired a property through a 1031 exchange, can I later make it my personal residence?

Question

What does the IRS say about moving into a property that was purchased as an investment? I have a fourplex, and one of the units will soon be vacant and I'd like to live there myself. If I did that, could the IRS go back and ding me for the capital gains on the original property that I sold in order to buy this one? Also, can I continue to claim depreciation on the three remaining units?

Answer 1

You walk a fine line. In order for you to have a valid 1031 exchange, you need to acquire a property of a similar kind that is used in a trade or business. Broadly speaking, if you move into the place, it will not be used in trade or business, and therefore you fail the 1031 test. The transaction will be taxable.

However, if you use the property in a t/b for a period of time and then convert it to a principal residence, then there will be sufficient time between the 1031 and the conversion to show that it was indeed used in a t/b. How much time is required is unknown.

in the case of split use property such as an apt complex, living in 1 of the units may be considered a partial failure of the 1031 while the reamining unit would be a successful 1031.

These are very factual inquiries that cannot be answered with any certainty on Yahoo!. You should consult professional advice.

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Answer 2

You can convert one of the units to your personal residence. In order to exclude gain on the sale of this unit as your personal residence, you have to live in the unit as your principal residence for five years (not two as in the usual case).

You can still depreciate the remaining units.

When you sell the building, 3/4 of the building is treated as a sale of property acquired in a 1031 exchange. The remaining unit, if you have lived in it for five years as your principal residence, is eligible for the exclusion on sale of principal residence (250K not married, 500K married). The depreciation on this unit when it was a 1031 property is recaptured (25% tax on this).

More details in Pub 523, see page 25 which includes references to other IRS sources discussing this topic.
http://www.irs.gov/pub/irs-pdf/p523.pdf