CONVERTING QUALIFIED USE PROPERTY FROM AN ExchangeTO PERSONAL USE 

Taxpayers who dispose of business or investment held property, that are interested in Paying No Capital Gains Tax  today, must structure their transaction as a like-kind Exchange, tax deferred Exchange, 1031 T.D.X., deferred Exchangeor Starker Exchange, they all mean one in the same. They must dispose and acquire other "like-kind" real property within six months of the closing of the relinquished property that is conveyed. In addition, the replacement property value has to be at least the same or greater than the value of the relinquished property that’s being disposed of to defer all gains tax. In order for the taxpayer, to receive this favorable tax treatment of deferring federal and state income tax associated with ones gain indefinitely, the transaction of a deferred Exchangemust be handled through the use of a professional "qualified intermediary". The qualified intermediary is in the business of structuring deferred Exchanges and works together with the taxpayer's real estate professional, accountant/cpa, attorney or title company to achieve a successful transaction. This professional must provide customary services that include acting as the qualified intermediary, meaning that either title needs to be conveyed of both the relinquished and replacement properties or the rights of both property contracts must be assigned to this professional. As well as acting as a "qualified escrow agent", providing all the necessary Exchangedocuments (not an amended sales contract), and acting as an advisor to the taxpayer's team of professionals involved in the Exchangetransaction. If the qualified intermediary does not  provide this type of service and is only acting as an escrow agent, your Exchangetransaction will not hold any water for I.R.S. purposes. Once you have completed a successful Exchangeby acquiring like-kind real property, what if you want to change that qualified use property into personal use? The conversion should not prevent the Exchangetransaction from satisfying the  qualifying use requirement provided the taxpayer did not have a concrete intention to convert the property to personal use at the time of the Exchange.

1 The taxpayer will have a difficult task establishing the investment or rental intent if the taxpayer acquires a replacement property and shortly thereafter converts it to personal use. Or if the taxpayer acquires land as replacement property and before or shortly after the completion of the Exchangetransaction, the taxpayer either has plans drawn up for a principal residence or vacation home or begins construction on a principal residence or vacation home. Some taxpayers will Exchangeinto land with the indeterminate intent to build a home at some time in the distant future and this intent should not disqualify the Exchange.

2 In one private letter ruling, the IRS ruled that a two-year minimum rental period was sufficient to meet the qualified use test.

3 Today, a taxpayer who successfully converts a business or investment held property into a primary residence may later exclude the gain for the sale of the residence under Internal Revenue Code Section "121", after the taxpayer has resided in the property for at least two years, (except for any depreciation expense adjustments for periods after May 6, 1997). 

1 Click v. Comm., 78 TC 225 (1982) 

2 Wagensen v. Comm., 74 TC 653 (1980) 

3 Ltr Rul 84290039