GARY GORMAN, MANAGER OF Professional Exchange Accommodators of Denver, provides an example of how a home owning client with a few stray rental properties can—in four easy steps—convert those investment properties into a personal residence and access the $500,00 gain excluding ($250,000 for singles) available to all home-owning taxpayers.

Step 1 The Smiths own four small rental houses, with a $100,000 gain in each, as well as a personal residence. They expect to retire in a few years and want to redeploy the funds they have invested in rental property to other assets more appropriate to retirees, like stocks and bonds. Using a qualified intermediary for the exchanges, they arrange to sell the four small homes and roll their proceeds and gains into one large house, which they buy for $400,000.

Step 2 The Smiths rent out the large house and live in their personal residence.

Step 3 At least a year after buying and renting out the large house, the Smiths well their persona residence, which they have live in for many years, excluding the $500,000 in gains realized on the sale.

They the move into the new house and invest the proceeds of the home sale to produce retirement income.

Step 4 Two years after moving into the new house they sell it for $500,000, realizing a $100,000 gain. This gain also qualifies for exclusion. (Remember that the exclusion on personal residences essentially renews every two years—the days of the once-in-a-lifetime exclusion are gone.)

The bottom line? As the Smiths enter retirement, they do so having realized $1million in gains tax-free, conceivably in as little as 36 months. (The shortest time period during which a 1031 exchange can be completed is 24 ½ months.)

They are free to take any portion of that money and buy a retirement home or invest it all and rent a home—it's entirely up to them and entirely untaxed.

In 2000 Congress attempted, if not to shut down this sort of tax alchemy, then at least to make it less attractive by lengthening the holding periods. The attempt was thwarted. Although moves to limit 1031 exchanges could be resurrected at some point, it's seen as unlikely during the next few years despite the recent power shift in the Senate, especially because congressional representatives of both parties face elections every two years.

—GR

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