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RD
RD, Certified Public Accountant (CPA)
Category: Tax
Satisfied Customers: 8784
Experience:  CPA, MBA, Over 10 yrs of experience in tax planning and business consulting..
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In June 2007 we sold two investment properties for ...

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In June 2007 we sold two investment properties for approximately $650,000 and using a 1031 exchange reinvested the money in a rental unit which we purchased for $1,300,000. In doing this we deferred a gain of about $450,000.

The new unit was immediately rented and we expect the tenants to be in place till August this year. We are considering converting the property to a second home that we would also use as a vacation rental.

As a high net income couple we are interested in deducting part of the mortgage on schedule A rather than having carry forward losses on schedule E.

Can we do this and are there any potential pitfalls?
Submitted: 8 years ago.
Category: Tax
Expert:  RD replied 8 years ago.

Since you have recently acquired this property using a section 1031 exchange, It would be advisable for you to keep it as a rental property for a reasonable period before converting it to second home. Though reasonable period is a very subjective term, I would suggest you should keep it as a rental property for atleast 1-2 years before converting it to second home. Waiting for such a period will reinforce your intention to buy a like kind investment property and hence, your sec 1031 exchange would not fail.

Btw, regarding mortgage interest- you cannot deduct interest for mortgage indebtedness for loans in excess of $1 mn. This amount will include debt for primary home and second home. Home equity indebtedness is limited to $100K. So in total interest on loan of $1.1 mn. is only deductible.

Let me know if you have any question.

 

Please note: This advice is provided with the understanding that all the relevant facts have been provided by you. Any change in facts might affect the advice given and hence may not be relied on in such cases. Nothing contained in this reply was intended or written to be used, can be used by any taxpayer, or may be relied upon or used by any taxpayer for the purposes of avoiding penalties that may be imposed on the taxpayer under the Internal Revenue Code of 1986, as amended.

Customer: replied 8 years ago.
Reply to RD's Post: My plan was always to hold the property a minimum of one year before converting it (June 2007 - September 2008).

What are the chances of losing an audit of this 1031 exchange? I understood that all the tax court precedents have ruled that a one year rental before conversion meets the reasonableness test.

In any event, if there is significant risk I could delay the conversion till January 2009 so that I would have two years of tax returns with the property as a rental.

Can you also supply details of how the splits of costs between Schedule E and Schedule A are done (or send links to appropriate documents).

If you can help out with these issues I will be happy to hit Accept!

Thanks,

Mike
Expert:  RD replied 8 years ago.

It is normally advised to atleast wait for a year before conversion.

Regarding splitting costs.....I will provide a link to the publication that will answer most of your questions.

http://www.irs.gov/publications/p527/ar02.html

Let me know if you have any question.

 

Please note: This advice is provided with the understanding that all the relevant facts have been provided by you. Any change in facts might affect the advice given and hence may not be relied on in such cases. Nothing contained in this reply was intended or written to be used, can be used by any taxpayer, or may be relied upon or used by any taxpayer for the purposes of avoiding penalties that may be imposed on the taxpayer under the Internal Revenue Code of 1986, as amended.

 

Customer: replied 8 years ago.
You didn't really answer the initial part of my question. Is there a phone number so that we could chat for a few minutes about this situation?

Mike
Expert:  RD replied 8 years ago.

Based on the terms of this website, I do not think I can provide you my phone number.

Regarding your question, as long as you have held the property for a reasonable period of time, the 1031 exchange will not fail.

I do think there is a way to chat. You can find more information on this by emailing at [email protected]

 

Let me know if you have any question.

 

Please note: This advice is provided with the understanding that all the relevant facts have been provided by you. Any change in facts might affect the advice given and hence may not be relied on in such cases. Nothing contained in this reply was intended or written to be used, can be used by any taxpayer, or may be relied upon or used by any taxpayer for the purposes of avoiding penalties that may be imposed on the

 

 

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