1031 Exchange Converted to Primary Residence Court Ruling

Last week a U.S. Tax Court ruled (T.C. Memo 2010-64) that replacement property acquired in a 1031 exchange did not meet the "held for" investment requirement after the taxpayer moved into the property two months after acquiring it.

In the fall of 2002, a couple placed an offer on a single family home in Georgia contingent upon the sale of their primary residence in California. A few months later the couple sold their home and moved in with some in-laws living in Georgia. In the spring of 2003, the couple sold some rental property in California and used a 1031 exchange through a Qualified Intermediary to complete the purchase of the Georgia single family home. The couple placed a "for rent" advertisement in a neighborhood newspaper for a few months, began work to finish the basement and, two months after acquisition, moved out of their in-laws house and moved into the Georgia home.

In the Tax Court's ruling against the taxpayers, they noted the short time frame between the acquisition and their conversion to a primary residence. They also noted the fact that they had made the purchase of the Georgia property contingent upon the sale of their California primary residence (and not the rental property). They dismissed, as irrelevant or non-persuasive, the facts presented by the couple that the Georgia purchase was not extravagent in relation to California property values or the fact that they moved in with in-laws. In its ruling the Court found that the taxpayers had contemplated the use of the Georgia property as a personal residence before the exchange. The couple was held liable for the tax payment deficience in 2003 and 2004 as well as accuracy-related penalties under section.

While conversion of an investment property to a primary residence or vacation home is permissible, this ruling points out that the held-for-investment intent should be clearly evidenced from the start. If you are considering the possibility that an investment property may some day become your primary residence or vacation home, substantial documentation of your investment efforts should be evident. While Section 1031 of the Code does not clearly define the amount of time required to hold something for investment purposes , previous cases and rulings have shown a year (or even better, two years) should usually pass between the acquisition, use as an investment property and conversion to a personal use.

If you are contemplating a 1031 exchange and are considering the future personal use of investment property, you should consult with your tax or legal professional. We also hope you will give 1031 Corporation a call at 888-367-1031 if we can be of any assistance with your 1031 exchange.