A 1031 on Residential Property? It's Possible

Section 1031 of the Internal Revenue Code, also known simply as 1031, defers taxes for gains on any property or asset if they're reinvested in a like-kind exchange. If you sold a $100,000 property for twice the amount, the $100,000 gain won't be subject to tax as long as it's invested in another property. This is in line with what Section 1031 actually says. It states that “no gain or loss shall be recognized on the exchange of property held for productive use in a trade or business.”

Speaking of trade or business, does this imply that simple homeowners aren't qualified for a 1031? While it states that the property must be for productive use, experts say homeowners can file a 1031 in a number of instances. In this case, you need to know the so-called “two-of-the-last-five-years rule” where the homeowner must have lived in the house for two years. It also states that the house has been turned into an investment property for the next three years.

One way to turn a residential property into an investment is by renting it out. Homeowners can move out of the house after their second year of residing there, but have to rent it out for the next three years to qualify for a 1031. Make sure you don't make your new home your primary residence before the two-year period, although there are efforts to reduce the time frame to just one year.