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Can You Exchange Your Primary Residence Under Section 1031?

Can You Exchange Your Primary Residence Under Section 1031?

Section 1031 of the IRS code explicitly prohibits private residences from eligibility for a 1031 exchange. So the intuitive answer is no. But if your home has extensive equity, you may be looking for ways to avoid a hefty tax bill when you sell.

Of course, you can use the 250,000/500,000 exclusion permitted by tax code on the sale of your primary residence. But that still leaves any equity above and beyond that amount (after you’ve subtracted the original purchase price and any capital improvements) exposed to capital gains taxes in the year of the sale.

If you want to ensure tax deferral of all capital gains taxes, then a bit of foresight and planning – and a bit of patience – can qualify your primary residence for the benefits of a 1031 exchange.

The first step is to convert your primary residence into a rental property. Then, rent out your primary residence for two years and a day. During that time, you can the enjoy rental income. After the two years is up, go ahead and put your new investment property (formerly your primary residence) on the market. As long as you put all the proceeds of the sale into a new investment property, you can avoid capital gains on the entire transaction.

You can continue to do as many 1031 exchanges as you’d like. And, if the investment property becomes part of your estate, your heirs can avoid the capital gains taxes altogether thanks to the step up in basis they receive on the inherited property.