Say you own an aging fourplex, and you’d rather own an oceanfront home you can retire to one day. If you simply sell the fourplex, you’d pay capital gains on any appreciation, as well as the depreciation recapture. Alternatively, you could use a 1031 exchange to purchase the perfect retirement home. In the first two years, your personal usage cannot exceed 14 days, and you’ll need to rent it for 10 times the number of personal use nights: at least 14 days per year.
Converting rental property acquired in a 1031 exchange to a primary residence blends Section 1031 with Section 121 that provides the $250,000/$500,000 exclusions. To benefit from Section 121, the converted property must be held for five years with the first two as a rental also known as non qualified use. At the end of five years, 3/5 of the gain is excluded given the $250,000 or $500,000 limits in Section 121.