1031 exchanges are the only way to defer paying capital gains taxes and recapture taxes when investment properties are sold. What’s the catch? A seller must purchase new investment property of equal or greater value and engage the services of a Qualified Intermediary to quarterback the transaction.

As the population ages, a growing number of sellers no longer want to own investment properties, but they also don't want to pay the hefty IRS tax bills associated with the sale of their buildings. Often the desire of many of these sellers is to use a 1031 exchange to purchase a dream home that can be considered their primary residence.

Until recently, purchasing a residence would not qualify as “like-kind” property for an exchange. If the purchased property was used as a residence by the taxpayer, the IRS would “fail” the exchange and the taxpayer would then be liable for any taxes that they had planned to defer when their buildings were sold.

Treasury to the rescue! Recently, the 1031 rules were modified. Now investment property owners may use the profits from their sales, 100% tax deferred, to purchase a house that will be used as their primary residence. Certain rules must be followed. For example:

1. The taxpayer must hold onto the new house for at least five years.
2. The house must first be leased to a tenant for at least two years.

And the icing on the cake? After five years, if the taxpayer decides to sell the house, in accordance with the IRS homeowner exemption rules, married couples can keep up to $500,000 of profit ($250,000 if single) without any future purchase requirements. Remember to consult with your tax advisor before exchanging.

Scott Nathanson is an attorney and the Regional Manager for the 1031 Qualified Intermediary, Nationwide Exchange Services (www.nationwide1031.com). Scott can be reached at (312) 960-5316.