President George W. Bush signed the American Jobs Creation Act (H.R. 4520) into law on October 22, 2004, which contains certain provisions that may affect the income tax consequences on the disposition (sale) of your primary residence if your primary residence was originally acquired as part of a prior 1031 exchange transaction.
Prior to the American Jobs Creation Act of 2004
You could dispose (sell) one of your rental or investment properties and acquire another like-kind replacement rental or investment property through a 1031 exchange. The like-kind replacement property acquired would typically be a single family residence that you would ultimately want to move into as your primary residence. However, the like-kind replacement property acquired must be held for rental or investment purposes in order to demonstrate your intent to hold the real property for investment. The big question or issue was how long did you have to hold the real property for investment purposes before you could convert the investment property into your primary residence and subsequently take advantage of the 121 Exclusion. 1031 exchange experts would typically recommend a holding period of 12 to 18 months so that you could easily demonstrate that your intent was to hold your real property as rental or investment property.
You would then move into the rental or investment property after the 12 to 18 month holding period and convert it into your new primary residence. The only requirement prior to the American Job Creation Act of 2004 was to own, live in and use the property as your primary residence for at least 24 months (two years) so that you would qualify for the 121 Exclusion. You could then sell your primary residence after the 24 months and exclude up to $250,000 in capital gains per owner, or up to $500,000 in capital gains if you're married and filing a joint income tax return, from your taxable income pursuant to Section 121 of the Internal Revenue Code.
The new income tax provisions contained within the American Jobs Creation Act of 2004 (H.R. 4520) created a new five (5) year holding requirement when you sell a primary residence that was acquired as part of a prior 1031 exchange in order to take advantage of the 121 Exclusion.
You must now hold (own, not live in) the real property for a total of five (5) years if you want to exclude capital gains from your taxable income pursuant to a 121 exclusion from the disposition (sale) of your primary residence that was originally acquired as a like-kind replacement property as part of a prior 1031 exchange transaction.
This new five (5) year holding requirement only applies if you want to take advantage of the 121 exclusion. The requirements are effective for dispositions (sales) of real property occurring (closing) on or after October 22, 2004.
You would begin by disposing of (selling) a rental or investment property and 1031 exchanging into another like-kind replacement property by completing a 1031 exchange. You would then need to hold this like-kind replacement property as investment property for at least 12 to 18 months in order to demonstrate your intent to hold the real property for investment purposes ("qualified use").
You would then move into the real property and convert it to your primary residence, and would have to own, live in and use the real property as your primary residence for at least 24 months, and would have to hold (own) the real property for a total of five (5) years in order to take advantage of the 121 Exclusion.
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