A
popular way of turning investment property into tax
free cash is to sell an investment property, such as
a four-plex, and then roll the gain into a single
family residence via a 1031 exchange. To qualify for
the exchange you have to hold the residence as
investment property for at least a year and a day,
and our clients typically do this by renting it, or
trying to rent it during this time.
Once
this investment period is up, they then move into
the residence and convert it to their home. Under
current law, if you live in a home as your primary
residence for at least two years, the exclusions
available to you under Section 121 (the IRS Code
Section governing the sale of your personal
residence -- and giving you a $250,000 exclusion if
you are single and $500,000 if you are married) are
available to you even though all, or most, of the
gain is rollover gain from your 1031 exchange.
In a
bill signed by President Bush, the time requirements
for owing the house in order to get the exclusions
under Section 121 are extended to five years. For
example, Fred and Sue sell their purple duplex and
defer their $400,000 gain by buying a single family
rental house. They have to rent, or try to rent this
house, for a year and a day before they can move
into it. Under the old law, they could move into the
house and live in it for two years, and then sell it
and the first $500,000 of gain would be excluded,
even if $400,000 of the gain was rollover gain from
their 1031 exchange. Under the new law they will
have to own the house for at least five years, and
live in it for at least two years in order to
exclude the gain.
Before you moan and groan about this change,
consider for a moment that under the old law you had
to own the property for three years in order to
exclude the gain -- the new law merely tacks two
years to the holding period, which isn't such a big
deal considering that the government is giving you
$500,000 (or even $250,000) tax free.