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The IRS statute requires that you use a qualified intermediary (QI) to perform your 1031 exchange. While it is possible for an attorney to provide this service, it doesn’t have to be an attorney and it can’t be an attorney you have utilized for any other matters. This is because the IRS statute also requires […]
Tenants In Common (TIC) is a wonderful little arrangement wherein multiple owners each have a deeded interest in a property. That interest is a percentage or portion of the property. But can investors who hold an investment as Tenant in Common still take advantage of a tax deferred 1031 Exchange?
Long answer short: YES! When you sell your TIC, you can each decide what you want to do with your slice of the pie.
- You can stay together as one 1031 Exchange or
- You can 1031 Exchange your portion while the other(s) to take cash or
- You can each do a 1031 Exchange into separate properties with your portion.
You’ve got great flexibility in how you transition out of a property held as tenants in common. Because each situation and investor has unique circumstances, always consult with your financial adviser before proceeding.
Many people know about the primary residence exclusion that allows them to take the first $250,000 in profit ($500,000 if you’re married) tax free after just two years of occupancy. And more and more people are learning about the opportunity to do that repeatedly. But, did you know that you can convert an investment property into your primary residence and take advantage of that tax break? Even if you used a 1031 Exchange into your investment property, it’s still an option.
Converting from Investment to Primary Residence
Here’s the deal on converting investment property into your primary residence:
- If you purchased the investment without a 1031 Exchange, you may change its use at any time. Simply use the property as your primary residence for two of the five years immediately preceding its sale.
- If you purchased the property with a 1031 Exchange, there are some special rules for the conversion and the exclusion is prorated.
Converting after a 1031 Exchange
As you may recall, you cannot use a 1031 Exchange to purchase a property you intend to use for your primary residence. You must use the 1031 to purchase property you intend to use for investment purposes.
However, you can convert a 1031 property into your primary residence after holding it for productive use in business or trade for a period of time. The key is:
- your initial intent to hold it for investment purposes and
- how you demonstrate that intent.
For example, if you 1031 into a property and then move right in, what was your demonstrated intent? To use it as your primary residence. Both your initial stated intent and your actions subsequent to purchase are key.
Special Rules after a 1031 Exchange
If you 1031 into a property and then use it as a rental for the next 24 months and do not use it for personal use more than 2 weeks or 10% of the number of days it is actually rented, then the IRS gives you a safe harbor and will never challenge your initial intent. In between day one and two years, there is a wide range of time for you to decide if you’ve owned it long enough and treated it as investment enough that you can change your intent and move in. An awful lot of folks feel good at anything more than a year. But, individual circumstances could allow a shorter (or longer) investment use period.
When you do convert the property into your primary residence, you will then get the benefit of the primary residence exclusion with some 1031 Exchange specific requirements.To qualify for any of the primary residence exclusion, you must have owned the converted property for no less than five years. In addition, you must have lived in it for two out of the five years prior to sale. And then you get to prorate the amount of gain between the period of “qualified use” (as a primary and tax-free) and “non-qualified use” (as an investment and you would pay tax on this portion). You also have to recapture all depreciation.
The Bottom Line
The conversion of an investment property into a your primary residence is an underutilized option that can be very beneficial. Over time, it can make the capital gains tax on your former investment property dwindle. This give you the opportunity to take all or a portion of your home sale proceeds tax-free.
As always, consult with your accountant to determine the best course of action for your financial situation.
Does it matter if you use a local or national 1031 Exchange Qualified Intermediary (QI)? Wouldn’t it be better to select someone you can meet in person? While some investors derive a sense of comfort from proximity, the closest QI may not be the right QI.
To carry out a 1031 Exchange, your QI must be in place before you sell your investment property. The geographic location of your QI is not a critical factor for either documentation preparation or real estate closings.
But what of your peace of mind? These are your hard-earned investment dollars we’re talking about.
No matter their physical location, your QI should be experienced, accessible and dependable. They should be able to guide you through the exchange process and help your exchange glide smoothly along. They should be responsive to inquiries and timely in their communication.
If you are buying and selling within your home city, a local QI should be familiar with that market. However, a well-versed national 1031 Exchange Qualified Intermediary may be better suited to help you carry out an exchange both locally and from state to state. Regardless, a QI with a significant history of successful exchanges may serve you better than one with the ability to drop by for a cup of coffee.
No matter what your preference, to qualify for a 1031 Exchange you must have your local or national QI in place prior to the sale of your investment property.
For more information visit the www.1031investor.com.
I will never regret the decade we lived on our sailboat, Odysea, while our four boys were young. So thankful that real estate investing combined with the judicious use of both section 121 and 1031 Exchanges allowed us to step off the beaten path and experience the live aboard lifestyle.
Using a 1031 Exchange to grow your real estate portfolio faster using Uncle Sam’s money is a strategy that has helped millions of investors.
But of all the things you need to know about a 1031 Exchange, the most important thing is that it must be in place BEFORE you sell your investment real estate. The moment you receive your sale proceeds, it’s TOO LATE and you will have to pay the tax. Many investors new to this tax deferral method have discovered this after their sale and paid for it – literally.
The great news is that even if you are closing tomorrow or don’t know when you will close, it is quick and easy to start your exchange. Once you know what title company will be handling the transaction, the exchange can be initiated on your behalf by your Qualified Intermediary (QI).
Initiating your exchange with a QI prior to your sale is a rule that is a critical thing to keep in mind as you continue to learn about 1031 exchanges. I hope you will use the free online resources here at www.the1031investor.com as you explore this option.
When it comes to selling investment property, depreciation is a gift with a catch. When you own the property depreciation tax deduction is a wonderful thing. The IRS essentially lets you pretend that your property is losing value at an even rate over 27 1/2 years (39 years if it’s a commercial property. You get to take that pretend loss as a tax write off – Bonus!!!
But wait. The IRS wants that tax break back when you sell the property. It is one of those “I’m from the government, and I’m here to help” kinds of things. And it gets even worse. Even if you have never taken the depreciation allowance tax benefit on your tax return, the IRS will make you pay back what you could have taken when you sell. That’s how naughty it is. In the words of Lord Bramwell “Like mothers, taxes are often misunderstood but seldom forgotten.”.
In comes the knight on shining horse – the 1031 exchange. When you complete a 1031 exchange you get to defer the tax on all gain and the dreaded “depreciation recapture”.
A 1031 exchange allows you to defer all capital gains tax and depreciation recapture when you sell and purchase investment property. The key to the 1031 is that you must use a 3rd-party qualified intermediary to manage the 1031 process. And they must be in place prior to the close of your sale—you cannot simply sell and reinvest. It is this intermediary who can guide you through the wilderness of IRS rules around tax deferral, so you don’t get burned by a helpful IRS.