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I live in a paid off house in Kansas City Missouri and I have 2 paid off rental properties here also. I eventually would like to move to Delaware. My idea is that I either do a 1031 exchange selling one of the rentals and buying a more expensive rental property in Delaware by about $200,000 more and then some day in the future, maybe in 4 years, move to Delaware and have that property become my primary residence. The alternative is to just sell the house I live in and use that money to purchase a rental in Delaware and then move into one of the rental properties here until that 4 or 5 years passes and then move to Delaware. I am not sure of the implications of moving into a property that was a 1031 exchange. Or for that matter the tax implications of moving into a property that was a rental, making it a primary residence for 4-5 years and then selling to move east. I am aware I would need an attorney who is versed in 1031 exchanges. I haven’t done that quite yet but thought I’d ask here to see if anyone had words of wisdom of how I should swing this conundrum.
Additional thoughts-
Typically, at least under current federal tax law, real property obtained in a 1031 exchange gets a step-up in basis to its fair market value at the owner’s death (DOD). For estate planning this is key because it eliminates the accumulated capital gains taxes that the owner deferred during their lifetime, allowing the estate or estate beneficiaries to the sell the inherited property using the date of death fair market value as tax basis or restart depreciation with the new DOD basis if rental will continue. If rental continues post DOD then getting a qualified appraisal at the DOD is important to establish the new tax basis.
Again, getting appropriate professional guidance can help avoid tax traps. Also. state tax rules may differ from federal rules for both the state the property is located in and the state of residency of the decedent, the estate and/or the beneficiaries.
I believe that the step up in the basis also eliminates the recaptured depreciation tax for those who inherit 1031 property. Recaptured depreciation is taxed as ordinary income and in some instances can exceed the capital gains tax.
We are getting into the tax code weeds.
I agree with you on your first sentence regarding inherited property eliminating recaptured depreciation to heirs.
On your your second sentence my understanding of how any gain on recaptured depreciation is taxed (i.e. ordinary, capital gain, etc.) depends on the type of property (generally IRC 1245 or IRC 1250) and other factors such as the deprecation method originally selected and holding period. IRS Pub 544 gets into the detail for anyone who wants to tax nerd out.
I was grateful for good tax software and those taxpayers who agreed to make appropriate tax elections back in the day when I was preparing returns in my CPA role to keep their tax matters simple for long term tax minimization purposes.
We have a high level of complexity in taxes that just seems to keep increasing. I am not optimistic that complexity will go away anytime soon.
The first option is easily doable as it is a typical forward 1031 exchange. As others have noted, the second option is more complicated. We did a forward 1031 5 years ago using IPX1031 which claims to be the largest 1031 company. Their expertise was impressive and the dollar amount of our exchange was large enough that it didn’t cost us anything. That is because 1031 companies make most of their income from investing the money they hold as the intermediary between the date you sell your current rental property and the date you close on your new rental property.