Avoid Capital Gains on Your Home With a 1031 Exchange (1031-121)

Avoiding Capital Gains with a 1031 Exchange (1031-121)

Under Section 121, you can sell your primary residence and exclude from taxable income up to $250,000 (single taxpayers) or $500,000 (married taxpayers filing jointly) in capital gains

A 1031-121 exchange allows the owner of, for example, an expensive house to use one benefit to exclude part of the gain from tax and the other to defer tax on the rest. And the gain excluded -- up to $250,000 for a single homeowner and $500,000 for a couple -- can be added to the "basis" of the new house, reducing the potential tax if it is sold.

The new break doesn't apply to all homeowners, only to those who have home offices, or those who convert their house -- or a portion of it – into a rental. The deferral applies only to the portion of the house used for commercial purposes.  In general, you must use part of the home "exclusively and regularly" as your principal place of business, or exclusively and regularly as a place to meet or deal with patients, clients or customers in the normal course of work -- or for rental use. If you are an employee, your business use must be for your employer's convenience, not yours

An Example of a 1031-121 Exchange

Suppose you own a commercial property in which you have a $400,000 capital gain. But rather than trade up for another investment property, you want to exchange for a "dream home" where you and your spouse can enjoy the good life. This can be done with careful planning and a Starker exchange.

The first step is to sell your investment property and have the sales proceeds held by a qualified third-party accommodator. The second step is to use those sales proceeds to acquire your ultimate dream home.

But that property must be a rental at the time of acquisition. Most tax advisers suggest renting it for at least six to 12 months after purchase to show rental intent. Then you can move in and convert it to your personal residence.

However, before you can sell the acquired residence and claim your $250,000 or $500,000 principal residence exemption of IRC 121, the Oct. 22, 2004 tax changes of Internal Revenue Code 121(d)(10) now require you to own the acquired residence at least five years and live in it as your principal residence at least 24 of the 60 months before its sale.

1031-121 Exchange Qualifications

You must have lived in your house for at least two of the past five years.
• The profit on the sale of your home must be greater than the capital- gains tax exclusion -- $500,000 for married joint filers.
• You must have established a home office or converted your home into a rental property, and you must purchase a similar property when you sell.

How to avoid or defer paying capital- gains taxes on the sale of your primary residence.
• Set up a home office or rent out your property. To qualify for a federal home-office tax deduction, you must use part of the home exclusively and regularly as your principal place of business, meaning for administrative or management  activities; as a place where the owner meets or deals with patients, clients or customers in the normal course of trade or business; or for rental use.
• Make sure you file Form 8829 to claim the home-office deduction, or the IRS may not recognize the office portion of your home.
• When you are ready to sell, you can claim the standard capital-gains tax exclusion, up to certain limits: $250,000 (for most singles) and $500,000 (for joint filers). To qualify for the full exclusion, you must have lived in the home and used it as your primary residence for at least two of the five years prior to the sale. If your gains exceed those limits due to the commercial portion, you can defer taxes on those gains by buying another commercial property, if that property is worth as much or more than the value of the commercial portion of the house you are selling.

For more information, visit www.nestegginvesting.com

1031 Exchange Review Project is Live!

Particularly given some of the lawsuits at 1031 Tax Group and the choppiness in the market, we think it's more important than ever to really research on your 1031 transaction.

To that end, we've launched 1031reviews.com which is our attempt to create a directory of registered reps, QIDs, and 1031 sponsors so that before you make a large investment, you can understand your options and get feedback from other investors.

To gather this feedback, we're working hard to add reviews and comments, so expect those functions to be coming soon. 

www.1031reviews.com