After using a property acquired as replacement property in a 1031 exchange for business use or investment, you may convert the property to a personal use property. Generally, under Section 121 of the Internal Revenue Code, if used as a primary residence for at least 24 months within the last five years, you may exclude $250,000 of gain ($500,000 if married, filing jointly). Of course, you cannot have taken the Section 121 exclusion within the past two years. However, under HR 4520 (The Jobs Act) signed into law on October 22, 2004, by President George W. Bush, properties acquired in a 1031 exchange must be owned for at least five years and used at least 24 months of the last five years before allowed to take the Section 121 exclusion. Under Section 121, regardless of whether or not a 1031 exchange was involved, you cannot exclude depreciation recapture from May 6, 1997 forward so some tax may be due on the sale.

The Housing Assistance Tax Act of 2008, signed by President George W. Bush on July 30, 2008, includes a modification to the Section 121 exclusion of gain on the sale of a primary residence.  This modification affects taxpayers who exchange into a residential property, and then later convert the property to a personal residence.

Effective January 1, 2009, the Section 121 exclusion will not apply to gain from the sale of the residence that is allocable to periods of "nonqualified use." Nonqualified use refers to periods when the property was not used as the principal residence.  This change applies to use as a second home as well as a rental property.

How does this affect 1031 planning?   Read Full Article