Both the relinquished and purchased property must be held for investment or trade or business purposes. Thus, personal residences generally do not qualify. In certain circumstances, it is possible to convert a personal residence or vacation home into an investment property at a later date, or to purchase a residence as the replacement property, and subsequently convert it from investment to personal use after treating it as investment property for at least 2 years.
One possible way of Limiting rather than deferring gain on the subsequent sale of property converted from investment use to a primary residence is available by using the §121(a) exclusion of gain on the sale of a principal residence, up to a maximum of $500,00 ($250,000 for single taxpayers). Since 2009 the deferral is limited to “Qualified ”vs“ Disqualified” years.
- The permanent exclusion under §121 requires a special holding period of 5 years in the case of property acquired in a §1031 transaction. Special Rules have been set out for this type of transaction under Code Section 840.
- Revenue Procedure 2008-16 now gives guidelines for vacation homes – Taxpayer must rent the property for a minimum of 14 days and limit personal use to 14 days or 10% of the time rented whichever is greater. And must do it for 2 years before the exchange and two years after the exchange.