Although the delayed exchange variation remains the most common format, many Exchangers have been exploring more creative §1031 exchange strategies. This overview briefly addresses some of the opportunities investors are utilizing.
Investors are combining the tax deferral benefits of an exchange (IRC §1031) with the tax exclusion advantages available under the primary residence tax rules (IRC §121). Exchanging into a replacement property that is initially “held for investment,” and at a later time converting this rental property into a primary residence, enables a property owner to obtain tax-free funds.
Under the primary residence tax rules, anyone living in a property as their primary residence for 24 months out of a 60-month period is eligible to keep $250,000 tax-free if filing as a single and $500,000 if filing jointly. This exclusion is available once every two years, giving property owners the ability to unlock equity that has previously remained tied up in their investment property.
Investment real estate located in resort or vacation areas may qualify for an exchange if the owner can establish that their “intent” was to hold the property for investment. Property owners in many resort destinations nationwide are exchanging for more desirable properties.
There is an increase in popularity of exchanges where there is a purchase of a fractional ownership interest in commercial real estate along with other co-owners.
The IRS released rules on September 15, 2000 providing a safe harbor for the purchase of a replacement property before selling the relinquished property (a “reverse exchange”). Investors now have guidance to pursue an excellent purchase opportunity before selling the property they currently own.
Some investors choose to build a new property from the ground up or buy an existing property which requires improvements or refurbishments. This opportunity to build a brand new property helps an investor acquire a replacement property that meets their long-term objectives and exact exchange requirements.
Combining a reverse exchange with an improvement exchange creates a perfect opportunity to purchase the new property first-and-begin making improvements to this property before the relinquished property is sold to a buyer.