I live in one side of my duplex. How are a sale and a 1031 split?

Two dwelling units are two properties for tax purposes, even under one roof and one deed

Reg. section 1.121-1(e)(1) says the exclusion does not apply to gain allocable to any portion of the property, separate from the dwelling unit, that you did not use as your home. The regulation borrows the dwelling-unit definition from section 280A(f)(1), and its own Example 3 is a townhouse whose basement apartment, with a kitchen and separate entrance, becomes a second dwelling unit that has to be allocated.

A side-by-side duplex is the plain case of that example. The IRS's Publication 527 already has you split mortgage interest and property taxes between the half you live in and the half you rent; the sale follows the same line.

The exchange side works because section 1031(a) covers real property held for investment, and Publication 544 excludes only real property used for personal purposes, such as your home. The rented unit is investment property; your unit is not.

Price, selling costs, basis and debt are each divided by the method you used for depreciation

Reg. section 1.121-1(e)(3) requires you to allocate both basis and amount realized using the same method you used to figure depreciation. Rev. Proc. 2005-14 adds that allocation by square footage is an appropriate method. For two equal units that is usually a 50/50 split.

Your rental unit's adjusted basis is its share of purchase price and improvements, less every dollar of depreciation allowed or allowable on it. Your own unit carries no depreciation, so its basis is simply its share of cost.

Divide the mortgage the same way. The rental unit's share of the loan paid off at closing is debt relief that the replacement has to match with new debt or added cash, which is covered in replace the mortgage or add cash.

Worked example: a $900,000 duplex where $250,000 is excluded and $290,000 is deferred

Hypothetical, round figures, selling costs ignored. You are single, bought a duplex of two equal units for $400,000, have lived in one unit for six years and claimed $40,000 of depreciation on the other. You sell for $900,000.

Your unit: $450,000 amount realized less $200,000 basis is a $250,000 gain, all excluded under section 121. The rented unit: $450,000 less an adjusted basis of $160,000 is a $290,000 gain, of which $40,000 is unrecaptured section 1250 gain taxed at up to 25% under Topic 409 if you simply sell.

Exchange the rental unit's $450,000 into replacement real estate of at least that value, with all of that unit's net proceeds held by a qualified intermediary, and the $290,000 is deferred. Your replacement basis starts at the $160,000 carried over, plus any cash you add. Run your own numbers with your CPA.

• Your unit: $250,000 gain, excluded, no reinvestment required.
• Rental unit: $290,000 gain, deferred, $450,000 to reinvest.
• Selling without an exchange: the same $290,000 is taxed in the year of sale, starting with the $40,000 depreciation layer.

The rented unit reaches the exclusion only if you also lived in it for two of the last five years

Publication 587 says you can exclude gain on a separate business or rental part only if you owned and lived in that part as your main home for at least two years of the five before the sale. Owners who moved from one side to the other can sometimes cover both units, inside one $250,000 or $500,000 cap.

Where both units qualify and gain remains, Rev. Proc. 2005-14 lets you apply section 121 first and section 1031 to what is left, with the depreciation always on the exchange side. That combined case is laid out in the former-home guide.

If your side of the gain exceeds the cap, the excess is taxable capital gain. A larger exclusion does not spill over to shelter the rental unit's gain.

Report the two halves separately, and set up the exchange paperwork for the rental share only

The Form 8824 instructions say that when property was used partly as a main home and partly for investment, you prepare two worksheet Forms 8824 and combine them on the form you file. If no exclusion applies to the rental part, that part is completed under the normal instructions; Publication 523 points any taxable gain on the business or rental part to Form 4797, and Topic 701 sends a taxable home gain to Form 8949 and Schedule D.

Before closing, give your intermediary the allocation so the exchange agreement and assignment cover the rental unit's share. Ask how it will document the split, because the regulations do not describe a split disbursement on a duplex by name. Line-by-line help is in how to fill out Form 8824.

For the replacement, the rental share can buy another small rental, or it can go into a fractional interest that Rev. Rul. 2004-86 treats as an interest in real property, such as a traditional DST. That keeps the reinvestment target to the rental unit's figure and needs no landlord work. Duplex-specific selling points are in the duplex and fourplex guide.