I received this email a few days ago from the 1031 exchange company I like. The article below describes some situations where people tried to do a 1031 exchange and turn it into there personal residence incorrectly and because of that not only had to pay the taxes but penalties in addition.
Doing it correctly can be a powerful way of getting some of your money out of your properties tax free but not without risk or planning. If memory serves me right (consult with these guys for professional advice) the property needs to be rented for 3 years before you move in. In addition there are other requirements involved and maybe Vince and Ryan can shed some light on those requirements.
Let’s just play this out and say you got all your ducks in a row you could potentially exchange into a single family home you wouldn’t mind living in, rent it out for the appropriate amount of time and get $250,000 if you are single and $500,000 tax free if you are married by moving in for 2Â years in a 5 year period.
I know quite a few people who have done this successfully and moved into there dream retirement home in San Diego using this method. Consider looking into it if you have an apartment building or other piece of real estate you would like to sell but don’t want to pay the taxes.
**BREAKING 1031 EXCHANGE NEWS!!!**
Goolsby v. Commissioner (April 1, 2010); T.C. Memo. 2010-64
How Soon After a Taxpayer acquires property through a 1031 exchange can the Taxpayer treat the property as a personal residence?
The Tax Court recently held that property acquired by taxpayers in a Section 1031 exchange did not qualify as replacement property when the taxpayers moved into the property two months after acquiring it.Â Taxpayers were also held liable for the accuracy-related penalty.
In October 2002 taxpayers signed a purchase agreement to acquire a single family property in Georgia (the Pebble Beach property). The purchase agreement was contingent upon sale of taxpayersâ€™ personal residence in California. In February 2003 taxpayers sold their principal residence in California and began living with their in-laws in Georgia. In March 2003 taxpayers sold rental property located in California and used a QI to structure an exchange. Taxpayers purchased the Pebble Beach property as replacement property.
The court ruled that taxpayers did not intend to hold the Pebble Beach property for productive use in a trade or business or for investment at the time of exchange, and therefore it was not valid replacement property. The court first noted that taxpayers moved into the Pebble Beach property two months after acquiring it. Further, they did not move into it temporarily until renters could be found. Their efforts to rent the Pebble Beach property were minimal. They merely placed an advertisement in a neighborhood newspaper for a few months, and no further efforts were made to gain more exposure for the Pebble Beach property. Moreover, taxpayers began preparations to finish the basement of the Pebble Beach property, having a builder obtain permits for construction, within two weeks of purchase.
The court surmised that taxpayers were contemplating use of the Pebble Beach property as a personal residence before the exchange. It noted that taxpayers made purchase of the Pebble Beach property contingent upon sale of their personal residence in California. They sought advice from the QI regarding whether they could move into the property if renters could not be found.Â Â Taxpayers did not research whether covenants of the homeowners association would allow for rental of the Pebble Beach property before the exchange. They also did not research rental opportunities in the area prior to the exchange.
Taxpayers contended that purchase of the Pebble Beach property was not extravagant when compared to costs of California properties. The court responded that the relative values of properties were irrelevant. Taxpayers also argued, as evidence of their intent not to reside at the Pebble Beach property that they lived with their in-laws upon their move to Georgia.Â The court dismissed this argument as non-persuasive.
The court also found the taxpayers liable for the accuracy related penalty due to a substantial understatement of tax.Â Taxpayers failed to present any evidence that they acted with reasonable cause and in good faith.Â The taxpayers did not use counsel and represented themselves.
This case highlights that taxpayers should not be too quick to move into property acquired in an exchange. They should make substantial efforts to rent the property and avoid evidence of intent to use it as a residence.Â Â The taxpayers asked the QI if they could move into the property if renters could not be found.Â You probably get this or similar questions from clients frequently.Â Be careful with your answers and let the client know about the fate of the Goolsbys.
If you have ANY 1031 Exchange inquiries, or questions relating to the above article, please contact our offices.Â Pacific Capital Exchange looks forward to meeting ALL YOUR 1031 EXCHANGE NEEDS!Â Call us today at 1-888-398-1031 or visit our website at www.pcx1031.com.
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