Owner Occupied 1031 Exchange Guide for Property Investors and Homeowners

If you're a property investor or homeowner looking to sell a primary residence and reinvest in a new property, an owner occupied 1031 exchange might be the perfect solution for you.

The IRS allows homeowners to defer capital gains taxes by exchanging their primary residence for another property of equal or greater value, as long as it meets the 1031 exchange requirements.

There are specific rules and deadlines to follow, so it's essential to understand the process before proceeding.

To qualify for an owner occupied 1031 exchange, you must have owned and lived in the property for at least two of the five years leading up to the sale.

Expand your knowledge: 1031 Exchange Rental Property to Primary Residence

You can use a 1031 exchange to defer capital gains taxes, but there are some specific rules to keep in mind when it comes to owner-occupied properties.

To qualify for a 1031 exchange, you must intend to hold the replacement property for investment purposes. If you buy a new property with the intention of making it your dream home, you'll be subject to capital gains taxes.

You can avoid this situation by following the IRS's rules for converting a 1031 exchange property into a primary residence. You must retain the property as a rental unit for at least two years before converting it.

To meet the IRS's requirements, you must rent the replacement property for at least 14 days during one of the two years of ownership. You can rent to anyone, but it must be at a fair rental market price and documented in writing.

Here are the specific requirements for renting out the property:

Additionally, your personal use of the property must not exceed 14 days or 10% of the total number of days you rented out the property within 12 months. This is to ensure that you're not using the property as your primary residence.

If you follow these rules, you can convert the 1031 exchange property into a primary residence after 24 months.

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You can do a 1031 exchange on a portion of your property, but only if it meets specific criteria. For example, if you own a fourplex and rent out three units, you might be able to exchange the rented units while treating the sale of your personal unit as a regular home sale.

The key is understanding how to separate the personal unit from the rental units for tax purposes. This is often the case with owner-occupied multi-family properties in 1031 exchanges.

You can exchange up to 75% of the property's value, as long as you're careful about how you structure the deal. This allows you to defer taxes on the gain from the sale of the rental units.

Keep in mind that you'll need to follow specific rules to qualify for a 1031 exchange on a portion of your property. This includes determining which units are considered "personal" and which are "rental" units.

Additional reading: 1031 Exchange Personal Property

You can do a 1031 exchange on a portion of your owner-occupied multi-family property, which is great news for investors.

For example, if you own a fourplex and live in one unit, you might be able to do a 1031 exchange on 75% of the property, which is the three rented units.

Partial 1031 exchanges are allowed by the IRS, which means you can deal with the personal-use portion of the property separately. This can be a useful solution, especially for owner-occupied multi-family properties.

Check this out: Can You Do a 1031 Exchange with a Family Member

You can use an owner-occupied multi-family property for a 1031 exchange, but it's a bit more complicated than other types of properties.

This strategy is popular because you can keep a close eye on your investment, qualify for owner-occupied financing rates, and offset your own housing costs with rental income from the other units.

You might be able to do a 1031 exchange on 75% of the property, like if you own a fourplex and live in one unit while renting out the other three.

The IRS rules for 1031 exchanges are clear: the properties involved must be held for productive use in a trade or business or for investment, which means personal residences don't qualify.

This is a common issue with owner-occupied multi-family properties in 1031 exchanges, as they can be a bit of both: a personal residence and an investment property.

For another approach, see: Can You Do a 1031 Exchange on a Rental Property

The exchange process for an owner-occupied 1031 exchange is a bit more complex than a traditional exchange, but it's still a viable option for property owners.

To qualify for an exchange, you'll need to identify a replacement property within 45 days of selling your relinquished property, which is the property you're using for personal residence.

You'll need to close on the replacement property within 180 days of selling your relinquished property, giving you a decent amount of time to find the right property.

One key thing to keep in mind is that the replacement property must be of equal or greater value than the relinquished property, and it must be used for the same or greater percentage of personal residence.

See what others are reading: Changing Ownership of Replacement Property after a 1031 Exchange