Two recent Tax Court cases show that investment property, which may be the subject of a tax deferred exchange under IRC Section 1031, may include property that is later converted into the owner's residence or that was previously the owner's residence. A 1031 tax deferred exchange occurs when like kind properties productively used in a business or trade or held for investment are essentially exchanged. When handled properly, the transaction becomes a tax deferred exchange allowing the real property owner to defer payment of the tax on the gain. Bottom line, while the sale of real property is a taxable, a 1031 exchange is not.
In Reesink v. Commissioner, the petitioner sold a San Francisco apartment building for $1.4 million. Reesink put the sale proceeds into a single-family residence which he then tried to rent. When his rental efforts were unsuccessful, Reesink moved his family into the single-family residence. The IRS disallowed Reesink’s treatment of the sale and later purchase as a tax-deferred 1031 exchange. The Tax Court ruled that since Reesink originally held the residence out for rent, though only for eight months, the sale and purchase qualified as a 1031 exchange.
In Adams v. Commissioner, Mr. Adams purchased a personal residence for $26 thousand where he lived for many years. After he moved, he rented his San Francisco residence until he sold it for $600 thousand. The sales proceeds were then used to purchase a new residence in Eureka, California, which Adams rented to his son. Adams treated the sale of the San Francisco residence and purchase of the Eureka residence as a 1031 exchange. The IRS disagreed. The Tax Court held the exchange qualified as a 1031 transaction since the son paid fair rental value for the Eureka home.
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