Is There a 5-Year Ownership Period Required for 1031 Exchanges?

Jeff Peterson

August 14, 2023

1031 Exchange

There is oftentimes confusion between the various rules and code sections applicable to different types of real property sale transactions. One of the more common questions we get is about a supposed 5-year ownership requirement. That’s our topic for this article.

Section 1031 Rules

There is no such 5-year rule under Section 1031 of the IRC. Section 1031 is for investment and business real property, and it states that:

No gain or loss shall be recognized on the exchange of real property held for productive use in a trade or business or for investment if such real property is exchanged solely for real property of like kind which is to be held either for productive use in a trade or business or for investment.

So for Section 1031, one must have held the real property for the qualified purpose of “productive use in a trade or business or for investment,” and the length of time is somewhat undefined in the IRC. For more information, see this video.

Principal Residence Exclusion

Under another, different and unrelated rule, for personal-use property such as one’s home, the Principal Residence Exclusion under Section 121(a) states that:

Gross income shall not include gain from the sale or exchange of property if, during the 5-year period ending on the date of the sale or exchange, such property has been owned and used by the taxpayer as the taxpayer’s principal residence for periods aggregating 2 years or more.

Under the In Principal Residence Exclusion for one’s home, there is a five year look back period; and in order to qualify for the exclusion, one must pass both ownership and usage tests: The two-out-of-five-year rule states that one must have: (1) Owned the property; and (2) Used as ones domicile (home) the property that is being sold for at least two years (24 months) in the five years prior to the sale closing. One can meet the ownership and use tests during different 2-year periods. However, one must meet both tests during the same 5-year look-back period ending on the date of the sale closing (when the benefits and burdens of ownership shift). Generally, one is not eligible to take the Principal Residence Exclusion if one has already excluded the gain from the sale of another home during the two-year period prior to the sale of your home. So one can only take advantage of the Principal Residence Exclusion every two years or more.

For more information See IRS Topic 701, and IRS Publication 523.