We often get asked by homeowners, especially those in high-cost markets like the Bay Area, if they can use a 1031 exchange to sell their primary home. While the process is complex, a 1031 exchange can help defer capital gains taxes on the sale of the primary home, making it a valuable option for homeowners in specific situations.
“It’s not an easy process. You need to work with somebody who knows real estate well, a 1031 exchange specialist, and your financial advisor. At Opes, we have helped people make it work.”
What is a 1031 Exchange?
A 1031 exchange lets you exchange an income-producing property for another income-producing property to help defer capital gains tax. The process is complicated because a personal residence does not typically qualify for tax benefits until a tenant is secured and the property is rented out for two years. Moreover, the new property you purchase also needs to be rented out before you can move in and make it your primary residence.
To illustrate, let’s think of the 1031 exchange strategy as a four-year process:
- Move out of your primary residence and rent your home.
- Sell your home through the 1031 exchange.
- Buy and rent another property.
- After holding the property as a rental for a time, move in and make it your primary residence.
After living in the home for two of the last five years, you may qualify for the $500,000 capital gains exclusion, for those who are married filing jointly. For homeowners in certain markets where gains exceed those limits, like those in Silicon Valley, this approach may be relevant.
Bay Area workers, especially those working in technology who have stock-based compensation and significant equity in their home, may feel complex planning around home sales and capital gains is an important step in their integrated financial plan.
Are You Ready to Take the Next Step?
While the 1031 exchange isn’t right for everyone, in specific situations it can be a valuable strategy. We recommend working with a knowledgeable team to help guide clients through the strict requirements, including:
- A real estate advisor, who can help evaluate potential properties and rental income opportunities
- A 1031 exchange specialist, to help adhere to deadlines, gather documents, and ensure IRS requirements are met
- A financial advisor, to integrate the strategy into the broader financial plan and long-term goals
At Opes, we understand navigating taxes can be daunting, but we’re here to help you prepare. To understand how a 1031 exchange may fit into your broader financial plan, please complete our Financial Evaluation to get started.
TRANSCRIPT
Mark Duvall (00:00:00 -02:15:23)
We’re asked from time to time whether somebody can use a 1031 exchange for their primary home. And first, let’s talk about, well, what is a 1031 exchange? It’s exchanging an income producing property for another income producing property in order to avoid a capital gains tax. So, the first thing that comes to mind, if that’s for your personal residence, is that you’re going to have to rent out your personal residence for a period of time, and then you’re also going to have to rent out what it is you buy.
When we’re advising people about this, you’re talking about a four year time frame in which somebody is renting or living in a second home in order to actually manage to get a 1031 exchange for their primary property. And you also get a $500,000 exemption from capital gains tax if you sell your primary property. So for most of the country, it doesn’t even make any sense to do a 1031 exchange.
But in high cost areas like the Bay Area, and if you’ve owned your home for several decades, then you do have enough gain to where it could actually make sense. But the process is not easy. You’d have to move out, rent out your property. Then it sells, having identified another property, you rent that property out and after a few more years- after a four year period you could move into that new property. It can become your new primary residence. And in the process, if you have still lived in that home for two of the last five years, then you can still get the $500,000 exemption. So there’s multiple pieces that can go on and can be helpful. You can avoid all of the capital gains tax on a highly appreciated home.
Not an easy process. You need to work with people. Somebody who knows real estate well. A 1031 exchange specialist and talk with your financial advisor. We happen to have helped people do this, so that you can actually make it work.
Written by: Mark Duvall
Disclaimer: Case Studies are provided for illustrative purposes only to provide an example of the firm’s client base, process, and methodology. The experiences portrayed herein are not representative of all firm clients. Other individual outcomes may vary based on their individual circumstances, and there can be no assurance that the firm will be able to achieve similar results in comparable situations. No portion of this case study is to be interpreted as a testimonial or endorsement of the firm’s financial and investment advisory services. Client tax situations are unique and specific, and you are encouraged to consult a tax professional to analyze your specific situation. This material has been prepared for informational purposes only, and is not intended to provide tax, legal or accounting advice; nothing contained in these materials should be taken as such. The opinions expressed in this article are not intended to provide specific advice or recommendations for any individual or on any specific tax strategy or security. The material is presented solely for information purposes and has been gathered from sources believed to be reliable, however Opes Wealth Management cannot guarantee the accuracy or completeness of such information, and certain information presented here may have been condensed or summarized from its original source. Advisory services are only offered to clients or prospective clients where Opes Wealth Management and its representatives are properly licensed or exempt from licensure. No advice may be rendered by Opes unless a client service agreement is in place.
