Mixed-Use Properties and 1031 Exchanges

What if I live on my farm?  What if my shop/office is part of my home? 

For many people, working and living on the same property is routine, whether as part of a farm, a home office or some other arrangement like a shop, daycare, or business-related storage. Claiming work-related expenses and depreciation is typically a part of those scenarios as well. So what happens when they decide to sell? 

We refer to such properties as having “mixed use,” combining work and living space in one place. When a sale occurs, both uses will have tax consequences that must be captured on your tax return(s). The business portion may have a taxable gain, either from appreciation or as a result of the depreciation taken, or perhaps both. In such a circumstance, can you effect a like-kind exchange and acquire suitable replacement property tax-free? 

In fact, you can do a 1031 exchange on mixed-use property. A careful valuation that captures the personal residence value and the business value is critical. Under Section 121, up to $250,000 of gain may be exempt from taxation ($500,000 for a married couple filing jointly) for the personal residence portion.  You must have lived in the residence two out of the previous five years. There is no requirement to “roll over” the funds into another residence, and you may claim this exemption every two years. 

The business portion may be exchanged for qualified property – real estate used for business or investment purposes. All the normal exchange requirements must be met, including timing, value and equity matching, and the rest. You may even purchase another mixed-use property as your replacement property, again taking into account the requirements for a tax-free exchange. 

There are subtleties and planning opportunities that may be favorable to you if you have a mixed-use property. Contact your exchange officer for more information.