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From the Financial Hotline

Call, fax or e-mail for answers to all your financial questions.

Date: 10/1/2017

Author: Financial Hotline


Q: I exchanged my rental property for another investment property in a 1031 Exchange. But now, due to a job change, I need to move into the property I traded for and make it my primary residence. Is that allowed?

A: There is a provision that allows you to move into the replacement property and convert it to your principal residence. And if you reside in it and own it the required period of time, you can use IRC Section 121 to exclude up to $250,000 of gain ($500,000 for married persons filing jointly) on the sale of your principal residence.

The key is your intention at the time you acquired the replacement property. You will need to show that you honestly acquired it for investment purposes and then had a significant change in circumstances that required you to make the change to personal residence.

There aren’t any ironclad rules for “change of circumstances” but If you just advertise it for rent while waiting to move into it that probably won’t pass the laugh test. Some other moves to avoid include, Customizing the home to your unique needs shortly after the closing, moving in after closing and making the contract to purchase contingent on the sale of your primary residence. And of course, make sure the home isn’t located in an area that forbids rental properties.

It is a good idea to also document the event that precipitated the change. Examples include, loss of job, divorce, disability, change in family size, etc.

The specific IRS rules are: The replacement property must be owned for at least 24 months immediately after the exchange (the qualifying period) and in each of the two 12-month periods in the qualifying period: (1) the taxpayer must rent the replacement property to another person at a fair rental for 14 days or more; and (2) the taxpayer’s personal use of the replacement property must not exceed the greater of 14 days or 10% of the number of days during the 12-month period that the dwelling unit is rented at fair rental. It can be rented to a family member as a principal residence so long as market rent is paid.

In order to qualify for the Section 121 exclusion of gain, you must use the home as your principal residence for at least 2 of the last 5 years prior to its sale. Also, Section 121 has a special rule for 1031 property that states that you have to own the home for at least 5 years (either as 1031 property or principal residence) before you sell it. Finally the amount of the exclusion you can claim will be prorated between the period of time it was your principal residence and the time that it wasn’t, and any depreciation you took will be taxable.

Q: I am selling my rental property and the buyer wants to know my ROI. What is he referring to?

A: ROI or “return on investment” is a measure used to estimate and evaluate the performance of an investment or to compare the performance of different investments. To calculate ROI, the net profit of an investment is divided by the amount of money invested and the results are expressed as a percentage or ratio.

For example, let’s say you paid cash for a $100,000 rental property. You also paid $2,000 in closing costs, and $8,000 for improvements – which makes your total investment $110,000.

For this example, let’s say you collected $1000 in rent every month for two years ($12,000 per year). Your expenses equal $2000 per year which gives you a $10,000 net profit per year ($12,000 -$2,000=$10,000).

To calculate your ROI, you divide the annual return ($10,000) by the total investment you originally made ($110,000). $10,000 divided by $110,000 = .09 Your ROI is 9%

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