Using 1031 exchange proceeds - Posted by Dan

Posted by Dave T on February 15, 2002 at 22:36:05:

The qualified intermediary receives the net proceeds from the sale of the relinquished property. The proceeds are held in an escrow account, then disbursed to the seller (actually to the settlement attorney or title company conducting the settlement) of the replacement property.

Using 1031 exchange proceeds - Posted by Dan

Posted by Dan on February 15, 2002 at 13:25:57:

I am in the middle of a 1031 exchange … I will defer a capital gains tax on around $50,000. The proceeds from my exchange are around $15,000 (i refinanced the property once to get the $ out before I sold). My question is this … if I use the proceeds to buy a property that I initially use as a rental for a year (so as to comply with 1031 rules that require the acquired property to be held for investment purposes) and then live there for two years before I sell … can I take the capital gain exclusion of $250,000 on the sale of a primary residence to “get out” of paying the capial gain tax which I defered through the 1031 exchange.

Re: Using 1031 exchange proceeds - Posted by Lor

Posted by Lor on February 15, 2002 at 22:27:41:

Dave is correct. I recently spoke to my RE Attorney about this and he suggested that the house be rented for two tax periods - so if you purchased the house in August 1999, you would not move in until Jan. 2001 so that it would show up on your taxes as a rental for two years.

Re: Using 1031 exchange proceeds - Posted by Dave T

Posted by Dave T on February 15, 2002 at 14:00:32:

The tax code is silent on the holding period required before converting property received in a 1031 exchange from investment to personal use.

I suggest that you instead defer to rules for 1031 exchanges between related parties. In essense, the investment use period must be at least two years for property received in a 1031 exchange by a related party.

If you convert from investment to personal use too soon, you risk that the IRS will claim that you never intended to acquire the replacement property for investment use and disqualify the exchange completely, recompute your taxes, and assess interest and penalties accordingly. The problem for us is that we do not know when investment use is long enough to satisfy the IRS. That is why I suggest using the related party two-year investment use rule as a precedent for your situation, since that timeline is specified in the tax code.

As I interpret the current rules, if your strategy is successful, you can exclude the capital gains tax, but the depreciation recapture would still have to be paid when you eventually sell that exchange property.

I assume that you are using a qualified intermediary to facilitate your exchange. If you do not complete the exchange you propose, then the sale of your investment property is a taxable event. It appears that you will receive enough cash from the proceeds of the sale to pay the capital gains taxes that will be due, though your depreciation recapture will still have to be taken into account.

In this period of stock market volatility, you may want to consider looking at some of your equity positions in the stock market. If you have a number of stocks that have unrealized capital losses, you might want to sell those stocks to realize the loss. Use your losses in the stock market to offset your capital gain on the sale of your investment property (hence, no capital gains tax due). If you really want those stocks in your portfolio, just buy them back 31 days later (at a lower price perhaps).

I am not a tax professional and do not pretend to be an expert. Suggest you consult a professional tax advisor before implementing your proposed plan.

Re: Using 1031 exchange proceeds - Posted by Mary

Posted by Mary on February 15, 2002 at 19:59:13:

In a 1031 transaction, does the qualified intermediary get the sales price or the net proceeds of the sale?