Q. I own a second home. It’s not a vacation home but one where I let my mother stay. She pays me a small amount of rent but I don’t declare it as income. She will soon be going into a nursing home. Am I able to use a 1031 exchange when I sell the house so I don’t have to pay capital gains taxes?
– Selling soonish
A. Based on what you’ve described, it seems a Section 1031 exchange won’t work for you.
In order to qualify for a 1031 exchange, both the property sold and the replacement property purchased must be held for either investment or business purposes, such as a rental property, said Len Nitti, a certified public accountant with Wilkin & Guttenplan in East Brunswick.
He said personal residences do not qualify for a tax-deferred Section 1031 exchange.
“The IRS considers a home rented to a family member for less than fair market value to be a personal residence,” said Nitti. “As it appears that this is the case with the home rented to your mother, the IRS would likely consider it a personal residence and therefore it wouldn’t qualify for a Section 1031 exchange.”
If you want to use a 1031 exchange for this property, you could consider renting it to a third party at fair market value to convert it to business property, Nitti said. Then you could sell the home in the future.
“Just keep in mind that the replacement property purchased would also need to be business or investment property,” he said.
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