This can be a very useful investment tool to an investor that wants to pull cash out of their real estate without having to pay sizable taxes. There are a number of factors that are used to establish a principal residence such as: (1) the length of occupancy; (2) the location of employment; (3) the principal place of abode for family members; (4) the address used on the taxpayer’s federal and state tax returns; (5) the address where the taxpayer is registered to vote; (6) the location of the taxpayer’s bank(s); (7) the address used for automobile and driver’s license registrations; and (8), the location of the taxpayer’s religious organizations and recreational clubs. It is important to keep in mind, though, that you can only have one principal residence at any given time.
Assume you own property in Hawaii (HI property) with considerable equity and property in California (CA property) that is your principal residence. You sell the HI property via a 1031 exchange and replace it on the Mainland with (new property) that will be adequate to you as a residence for four years. You rent the new property for one year so that it qualifies for a 1031 exchange and then occupy it as your principal residence for four years to meet both the five years of ownership and the two out of five years exclusion requirement. Then you sell the new property and take the exclusion. If it is rented for one year and occupied for four years, the amount of gain being taxed, for your non-resident use would be 1/5 or 20%; i.e., only 20% of the gain would be taxable. You can only do this once every two years, so before you start, you should plan what you want to do with the CA property. You might want to sell it early on and take the exclusion. This would enable you to exclude gain from the CA property and the sale of the HI property as well as any gain from the sale of the new property.
Many readers of the newsletter alternate between living on the Mainland and in Hawaii with most of them claiming their Mainland home as a principal residence and their Hawaii home as a second home. Some of them may find it beneficial to shift their principal residence to Hawaii in order to claim the two out five-year exclusion. You have to occupy a principal residence for two out of the past five years to qualify for the exclusion; however, the months of occupancy do not need to be continuous. Moreover, you don’t need to actually have lived in it for two full years; e.g., an owner that now alternates between living in Hawaii and on the Mainland with their principal residence being their Mainland home, doesn’t change their principal residence each time they live for part of the year in Hawaii. Assume you own a HI property and a primary residence in CA. You start the process by shifting your primary residence to the HI property. However, the day you make that change is also the day that you can no longer claim the CA property as your primary residence. So you may also want to sell the CA property early on and take the exclusions.
Converting a Second Home Into a Principal Residence
This can be a very useful investment tool to an investor that wants to pull cash out of their real estate without having to pay sizable taxes. There are a number of factors that are used to establish a principal residence such as: (1) the length of occupancy; (2) the location of employment; (3) the principal place of abode for family members; (4) the address used on the taxpayer’s federal and state tax returns; (5) the address where the taxpayer is registered to vote; (6) the location of the taxpayer’s bank(s); (7) the address used for automobile and driver’s license registrations; and (8), the location of the taxpayer’s religious organizations and recreational clubs. It is important to keep in mind, though, that you can only have one principal residence at any given time.
Assume you own property in Hawaii (HI property) with considerable equity and property in California (CA property) that is your principal residence. You sell the HI property via a 1031 exchange and replace it on the Mainland with (new property) that will be adequate to you as a residence for four years. You rent the new property for one year so that it qualifies for a 1031 exchange and then occupy it as your principal residence for four years to meet both the five years of ownership and the two out of five years exclusion requirement. Then you sell the new property and take the exclusion. If it is rented for one year and occupied for four years, the amount of gain being taxed, for your non-resident use would be 1/5 or 20%; i.e., only 20% of the gain would be taxable. You can only do this once every two years, so before you start, you should plan what you want to do with the CA property. You might want to sell it early on and take the exclusion. This would enable you to exclude gain from the CA property and the sale of the HI property as well as any gain from the sale of the new property.
Many readers of the newsletter alternate between living on the Mainland and in Hawaii with most of them claiming their Mainland home as a principal residence and their Hawaii home as a second home. Some of them may find it beneficial to shift their principal residence to Hawaii in order to claim the two out five-year exclusion. You have to occupy a principal residence for two out of the past five years to qualify for the exclusion; however, the months of occupancy do not need to be continuous. Moreover, you don’t need to actually have lived in it for two full years; e.g., an owner that now alternates between living in Hawaii and on the Mainland with their principal residence being their Mainland home, doesn’t change their principal residence each time they live for part of the year in Hawaii. Assume you own a HI property and a primary residence in CA. You start the process by shifting your primary residence to the HI property. However, the day you make that change is also the day that you can no longer claim the CA property as your primary residence. So you may also want to sell the CA property early on and take the exclusions.