Mixed Use Exchanges: Section 1031 and Section 121

Mixed use 1031 exchanges are conducted when there is a portion of the property that qualifies as property held for use in a business or investment while the other portion is a primary residence. Under Section 121 of the Internal Revenue Code (IRC), the personal residence qualifies for $250,000/$500,000 exclusion on the gain. 

Ranches, farms and duplexes are examples of mixed use properties. The residential portion is typically defined as that portion of the yard around the personal residence where the grass is cut during the growing seasons.

Section 121

According to the IRC Section 121, the owners of the home are each allowed a $250,000 exclusion for both the husband and wife, filing a joint return given during a five year period ending on the date of the sale or exchange, the home served as the taxpayer's primary residence principal residence for at least two years. The Section 121 exclusion may be utilized once every two years. Those taxpayer's who for reasons of changes in employment or health fail to meet the two year use requirement, may take a prorated fraction of the $250,000 per taxpayer exclusion.

Example

When a farm is sold that includes a farmhouse, and the taxpayer meets the personal residence use requirements, the personal residence is separated from the total farm sales price with the balance sold as property held for use in business or for investment. If the taxpayer wishes to defer the gain and purchase replacement property, a 1031 exchange is initiated.