re: 1031 Exchange Question

You got two issues.

1) If it becomes personal property, how do you get the 121 home sale exclusion (since your gain will be higher due to the deferred gain from the 1031 exchange).

2) How do you prevent the IRS from applying step doctrine and blowing up the 1031 exchange and forcing you to pay the tax on the gain in the exchange year (and this may happen on audit several years later).

In order to take advantage of the Sec 121 home sale exclusion, you have to hold the new property for 5 full years (in addition to having it be your personal residence for 2 years of those 5).

To make sure the IRS doesn't toss out the original 1031 exchange deferral, You have to prove that you intended to keep the new property as investment, but that situations changed after you acquired the replacement property.

There is a safe harbor available, the IRS won't toss the original 1031...

1) You have to own the replacement property for at least 24 months
2) divide that 24 month period into two equal 12 month periods
3) you must rent out the house for at least 14 days, at a fair market rent, during each period
4) your personal use can't exceed the greater of a) 14 days or b) 10 percent of the rental days, during each period.

If you fail the safe harbor, then you can try to argue facts and circumstances and intent at the IRS. There are no guarantees there.

I think your CPA has a right to be concerned, if you were my client, I would probably have you sign something saying your intention was to keep it as investment property. That's to protect me, by the way, not you =)