COMBINED 1031 EXCHANGE & 121 EXCLUSION


COMBINED 1031 EXCHANGE & 121 EXCLUSION

An Extraordinarily Effective Income Tax Strategy

The joining of a 1031 Exchange with a 121 Exclusion is an extraordinarily effective combined income tax strategy for real estate investors allowing them to take advantage of tax free exclusion when their property was previously held and used as investment property. Both of these sections are among the most financially beneficial provisions of the tax code. Just by themselves, each of these sections has the potential to save taxpayers hundreds of thousands – and even millions, if Section 121 be used repeatedly – of dollars in taxes.

 

Section 121 refers specifically to personal residences, while Section 1031 refers to real property held for investment or business purposes . Combining the 1031 exchange with the 121 exclusion can be one of the most powerful income tax planning tools available to you.  Here is a brief overview of this combined tax planning strategy.  It will also outline and incorporate the various legislative acts and IRS rulings that have impacted your ability to implement the various structures.

Legislative Acts and IRS Rulings

Congress enacted the American Jobs Creation Act of 2004 and then the Housing and Economic Recovery Act of 2008.  These two Acts both amend Section 121 of the Internal Revenue Code adding restrictions as to how you can take advantage of the tax free exclusion when your property was previously held and used as investment property.

 

The Department of the Treasury issued Revenue Procedure 2005-14 and then Revenue Procedure 2008-16.  These two Revenue Procedures actually provide very helpful and favorable guidance for the structuring of your 1031 exchange transactions.

1031 Exchange - Investment Property

Congress enacted the American Jobs Creation Act of 2004 and then the Housing and Economic Recovery Act of 2008.  These two Acts both amend Section 121 of the Internal Revenue Code adding restrictions as to how you can take advantage of the tax free exclusion when your property was previously held and used as investment property.

 

The Department of the Treasury issued Revenue Procedure 2005-14 and then Revenue Procedure 2008-16.  These two Revenue Procedures actually provide very helpful and favorable guidance for the structuring of your 1031 exchange transactions.

121 Exclusion

Section 121 of the Internal Revenue Code ("121 exclusion") provides that property held and used by you as your primary residence for at least 24 months out of the last 60 months can be sold and you can exclude from your taxable income up to $250,000.00 in capital gains if you are single (per homeowner/person) and up to $500,000.00 in capital gains for a married couple filing a joint income tax return.

The 121 exclusion can only be used in conjunction with real property that has been held and used as your primary residence. It does not apply to second homes, vacation homes, or any kind of property that has been held for rental, investment of use in your business except where a combined 1031 exchange and 121 exclusion strategy is appropriate.

You can only exclude capital gains (not depreciation recapture) from your taxable income when you sell your primary residence that was also held as an investment property. The depreciation recapture would be recognized in the year the primary residence is sold even if you qualify for the 121 exclusion.

Read More: Exeter 1031

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