Q: We did a 1031 Exchange last year. We rented the house back to the previous owners for three months and have advertised the home for rent every month for the last nine months without success.

It is very expensive to keep up with all the expenses on our house and the rental house. We planned on renting the house for at least two years. However, since we are not getting a renter, when would it be legally safe to move into this property as our primary residence?

A: A 1031 exchange is a mechanism used to defer paying tax on gains realized from the sale of an investment property. To defer these taxes, the seller of an investment property buys a replacement property of equal or higher value. The seller has to satisfy timing requirements and other rules, but when she does, she is able to sell and buy a new property without having to pay the IRS any taxes. But keep in mind that the new property that is purchased must be used for investment purposes.

If you want to convert the investment property into your primary residence, you must wait two years. If you don’t wait the two years, the IRS may decide that your 1031 exchange was invalid and tax you on the profits made from the sale of the property you previously sold.

You should talk to your accountant on this issue to decide whether paying the taxes owed on the sale is less than keeping the property while it sits vacant accruing expenses.

Published: Dec 5, 2005