FREE NEWSLETTER
Go to main Forum page »
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.
This is wonderful…thanks to all. Complex is the main word here. Will get to the articles, eventually keep very good records and hope my decision, when the time comes, is the best one due to the advice here and what I read and get professional advice on. Many thanks…
Additional thoughts –
If during the current tax year you transferred property to another party in a like-kind exchange, you must file Form 8824 with your tax return for that year.
A key takeaway – Filing Form 8824 is mandatory for taxpayers who complete a like-kind exchange and need to report the details of the transaction on their tax returns.
Here is a link to the 2024 IRS instructions for Form 8824.
Laura, I went back and found an excellent article by Michael Kitces that addresses the tax I’m plications of many of the questions you asked.
Great reference to the on point 2014 Kitces article Rick. That article should give Laura a guide path to the data she needs to gather.
Best, Bill
Thanks Bill
Laura, Dan and William provide good advice. I wrote about some of these issues a few years ago in conjunction with purchasing a home, making that home our primary residence, and converting our previous primary home – a beach town home – into a part-time rental with occasional personal use. At the time I spoke with a 1031 Exchange specialist. They gave me a lot of good, free advice. The rules for pro-rating qualified use (primary home) and non-qualified usage (non-primary home) are complex, even without a 1031 exchange. Best of luck.
Full disclosure, I never prepared a tax return with these issues, and would refer the client to a preparer above my pay grade. That would probably be an Enrolled Agent (EA) with experience doing this type of return.
There are several moving parts to be considered. One is the $250/$500k pass on the profit from the sale of a primary residence. If it’s a house that had been a rental in the past, then the deduction is prorated based on the ratio of time used for each purpose.
The next calculation is the recapture of depreciation from the time it was a rental.
Complexity is further increased if a 1031 exchange is involved.
The best advice I can share is for you to find a preparer that has done these in the past, and to keep fastidious records.
If one of our CPAs wants to chime in, that would be awesome.
I recommend a 2024 article from the AICPA publication The Tax Advisor as a overview you can read here.
That article ends in the following –
Sec. 1031 transactions can be highly technical and complex due to various moving parts that can easily affect the intended outcome. As a result, it is advisable to consult with a tax professional and QI to fully understand the rules and requirements of like-kind exchanges under Sec. 1031.
My words of wisdom is that if you do not have a substantial gain in the potential 1031 exchange to defer it is easy to spend more in professional fees than you may save in taxes. Don’t let the tail wag the dog by reducing future ordinary tax rate depreciation deduction by foregoing current capital gains taxed at a lower or zero capital gains rate. If your current rental properties are single family dwellings I would not expect any unrealized gain to be substantial in my thinking.
Like Dan, I hope our comments help.