Right now, I’m going to show you how to do a 1031 exchange with your primary residence.
Because here’s the problem – you may have used your primary residence in the past as a rental, or you may be planning to use it as a rental in the future, and you’d like to take advantage of all the tax breaks that are available to you.
So, let me show you some of them.
And real quick, a 1031 exchange is when you sell one rental property and buy another rental property using very specific IRS rules and timelines. This enables you to defer capital gains taxes and even other taxes sometimes forever, thereby building generational wealth for your family. Just like the big investors do.
How to do a 1031 exchange with your primary residence.
Did you know that you can do that? Well, this is what we’re going to talk about.
Chapter 1: Introducing the Combo
“The Combo” is a 1031 exchange including the benefits of IRS 121 for your primary residence.
We will define IRS 1031, and we will define IRS 121, and then we’ll talk about the various ways they can be combined.
And just a note, we must include both with specific timelines and rules.
Here is a brief definition of a 1031 exchange. This is when you sell one rental and you buy another, following IRS rules and timelines using a qualified intermediary.
When you do this, you can defer your capital gains taxes, including federal and state, depreciation recapture, and NIIT, commonly known as Medicare tax, sometimes forever.
Note that I put a note here, because defer means that you postpone it, maybe forever, maybe with your, continued 1031 exchanges.
This will differ from your 121 in the next slide, which is actually an exemption.
And the real, real benefit of this is you can use the savings on your taxes that you would have paid to the IRS to build generational wealth for your family, just like the big investors do.
Now for a brief definition of IRS 121. This is the tax rule that applies to your primary residence. Sometimes it’s called the main residence, sometimes a principal residence, but it’s where you live. This is a primary residence capital gains tax exemption.
Note, little arrow here that says note, it’s underlined. Exemption. What’s the difference? You’re totally exempt from paying certain capital gains taxes in this case. Here’s some of the rules. Your home must be owned and occupied by you two or more years out of the last five years. Then you sell your home.
And you can exempt up to $250,000 of your capital gains from taxation if you file your tax return as a single person. And why did I put up to? That’s because you might not have that much of a capital gain. It may be less than $250,000, so you can’t accept more than you, than you have.
However If you file as a married couple, you can exempt up to $500,000 of your gain when you file your tax return.
What’s really neat about this exemption is that you can use it once every two years with no limit. Some people buy personal residences and sell them in a serial order and keep saving taxes.
Chapter 2: Different combo methods
And here’s an overview, since we’ll go over them a little more in detail.
The property can be your home, and then a rental. It can be a rental, then your home.
Or, you could have acquired it in an exchange, a 1031 exchange, then it becomes a rental, because we all know that it must be a rental in an exchange, then it’s your personal residence, then maybe a rental again. And I will go over these in more detail next.
Let’s say the property was your home and then became a rental.
You lived in the home as your primary residence for at least three years. And that becomes a little clearer because of the time period to hold it.
And let’s say your value increases.
To take advantage of a 1031 exchange, you must turn it into a rental for several years, and then report the rent on your tax return. So it is an investment property now.
After the two or three years, you sell and exchange, meaning that part of the income tax will say that you’ve exchanged, but you allocate the values between the home and the rental periods. If you only rented it for a year or two and you owned it for many years, then you would be having less depreciation, and your tax advisor would allocate it separately. The reason you allocate the periods is because it depends how much time you use it as a home and how long you use it as a rental. But you take advantage of the benefits of the 121 because you lived in it at least two of the last five years.
And the IRS 1031 because it was an investment property. But you do have to use 1031 and exchange into another rental property or oil lease or Delaware Statutory Trust or something that your tax advisor suggests. And then you could include both of them together.
The second possible combination. is it was a rental, then it became your home.
And let’s say you own the property as a rental at least three years and it went up in value. You move into the property as your primary residence for two or three years and then you rent the home out again for one to two years.
Remember, you need to live in it for two of the last five years. You sell it, because you have no taxes unless you sell it, so you sell it.
And then you combine and use 1031 and 121, again, allocating values, meaning in the time that you owned it and the value changes between your primary residential time and your time as a rental.
Again, I suggest using a tax advisor or tax preparer who really understands your tax returns and this combination.
A third possible method is that you acquired the property in a 1031 exchange and it was a rental and the reason it was a rental is we all know that if you acquire it in an exchange that it must be a rental. But then later on you make it your home.
There’s a special rule on properties that you acquire an exchange and then turn into a home and you must own it for a minimum of five years. Okay, so your rental home was acquired in a 1031 exchange and you rent it out for at least three years.
Then you move in and live in it as your primary residence for at least two years.
When you sell it, because remember we’re selling it to have a capital gain, you allocate the values between the time as a rental and the time as your home. And in case of it being your home,
you’re going to take advantage of the IRS 121 – you will have lived in it two out of the last five years – and IRS 1031, where it was an investment, a rental for part of that time. And you can exchange that proportion or that section of it that you have left over after your 121 exemptions.
Now what happens in real life?
Chapter 3. Real-life Examples
This is one that I actually have worked on. So, here’s the story. A single man bought this home for $300,000.
He lived in it. Then he rented it out when he was transferred.
Then he moved back in.
He got married and then he deeded the house so that he owned it jointly with his spouse.
They moved out, actually bought a bigger house and rented it out for two years. So, they were living in it two of the last five years and it was an investment for part of the time before that, at least two years.
The big key here is they sold it for $975,000. They took the exemption of $500,000 off their capital gains because they’re a married couple So they used 121, IRS 121, and then for the remainder, they did a 1031 exchange, and they actually, bought an oil lease, because it wasn’t a lot, if you think about it, they got most of their exemption of their taxes off of the 121 exemption, But, they ended up with no taxes at all.
And later on, they may use the remainder that they did exchange into an oil lease for another investment.
Oh, and if we haven’t met, my name is Maxine Golden. I am a longtime real estate broker, and I started the 1031 Exchange Lady channel because I believe that you deserve the same tax breaks as the big investors. The law says you do, and you do. But don’t just take my word for it. Ask your accountant or ask the IRS. They will tell you the same thing.
So, I help rental property owners like yourself to sell their properties and defer their taxes.
Sometimes I help you and sometimes I refer you to qualified agents across America. So ask me your questions in the comments or see below to book a call. I look forward to seeing you in the next video.