A 1031 exchange is a method that taxpayers can use to defer the payment of capital gains when they sell real estate under certain circumstances. For the transaction to succeed, it must involve the exchange of one investment property for another, and the properties must meet the IRS' definition of "like-kind." In addition, there are some other crucial rules governing the process, all of which the taxpayer must follow to avoid disqualification of the deferral:
The short answer to this question is a clear no. Since your primary residence is not considered an investment property, you can’t use a 1031 exchange to defer the payment of capital gains taxes if you sell it. However, the good news is that you will have limited liability for the gains realized on a residence in most cases. Single taxpayers are allowed an exemption for the first $250,000 in capital gains for a personal home, while married couples can exempt double that amount. Taxpayers can claim the exemption every two years, but you must have lived in the home for at least two of the last five years (they don’t have to be the most recent two).
However, suppose you own a four-plex and live in one of the four units, renting out the other three. Now the situation is a bit more complex. The unit you live in is a personal residence, and when you sell the property, you can claim the exemption for the capital gain (up to the limit). But the three units that you rent to others (assuming you rent them at fair market value) are investments and can be eligible for 1031 exchange treatment.
Suppose that your cost basis in the property is $1 million, not including the land, and after owning it and living in one unit for three years, you sell the four-plex for $1.4 million. Since you can claim the personal exemption for the gain of $100,000 on the unit that is personal, you would have a capital gain on the investment property portion of $300,000. Therefore, you can consider pursuing a 1031 exchange to obtain replacement property valued at $300,000 (following the 1031 requirements) to defer that tax payment.