When considering whether you can live in a property acquired through a 1031 exchange, it's important to understand the requirements and implications of such a decision. The primary purpose of a 1031 exchange is to defer capital gains taxes by exchanging like-kind properties held for investment or business use. Living in a 1031 exchange property can complicate this purpose, but it is possible under certain conditions.

To qualify for a 1031 exchange, the property must be held for productive use in a trade or business or for investment. If you intend to live in the property, it must first meet the criteria of being held for investment purposes. According to Rev. Proc. 2008-16, a dwelling unit can qualify for like-kind exchange treatment if it is owned by the taxpayer for at least 24 months immediately before the exchange, and within that 24-month period, the taxpayer rents the dwelling unit to another person at a fair rental for at least 14 days in each of the two 12-month periods. Personal use of the property should not exceed the greater of 14 days or 10% of the days it is rented.

If you wish to convert the property to your personal residence after the exchange, you must be mindful of the holding period requirements. The IRS requires that the property be held for investment purposes for a reasonable period before converting it to a personal residence. While there is no specific time frame defined by the IRS, a common guideline is to hold the property for at least two years as an investment before making it your primary residence.

Let's illustrate this with an example:

Imagine you own a rental property that you decide to sell through a 1031 exchange. You sell the property for $500,000 and use Deferred.com as your qualified intermediary to facilitate the exchange. You identify and purchase a replacement property for $600,000, which you intend to rent out. You rent this new property to tenants for two years, meeting the requirements of renting it for at least 14 days each year at a fair rental value.

After two years, you decide to move into the property and make it your primary residence. By doing so, you have satisfied the investment use requirement and can now convert the property to personal use. However, it's important to note that if you sell the property in the future, the gain attributable to the period it was used as an investment property will not be eligible for the Section 121 exclusion, which allows for the exclusion of up to $250,000 ($500,000 for married couples) of gain on the sale of a primary residence.

In this scenario, Deferred.com played a crucial role as the qualified intermediary, ensuring the exchange was executed properly and helping you defer capital gains taxes on the initial sale. By adhering to the guidelines and holding the property for investment purposes before converting it to a personal residence, you can successfully navigate the complexities of living in a 1031 exchange property.