If I move into my 1031 replacement, can I later sell it tax-free?

The five-year bar starts at the closing on your replacement, not the night you move in

Section 121(d)(10) is a cliff for five years. Where you acquired property in an exchange on which gain went unrecognized under section 1031, the exclusion "shall not apply to the sale or exchange of such property by such taxpayer ... during the 5-year period beginning with the date of such acquisition" (26 U.S.C. §121).

That date is the day title to the replacement passed to you at the end of the exchange, so the period is already running while tenants are still in the house. Occupying the property earlier shortens nothing, and selling on year four gives you no exclusion at all rather than a reduced one.

The bar follows the property. The same paragraph reaches any person whose basis is determined by reference to yours, so gifting the house to a child inside the five years does not restart the arithmetic for them.

Two years of residence inside the last five is a separate test you also have to pass

Section 121(a) excludes gain only where, during the five-year period ending on the date of sale, the property was owned and used as your principal residence for periods aggregating two years or more. Clearing 121(d)(10) does not satisfy 121(a): both have to be true on the day you sign.

The ceiling is $250,000, lifted to $500,000 on a joint return where either spouse meets the ownership requirement, both meet the use requirement, and neither is disqualified by a recent exclusion (§121(b)(2)(A)).

Section 121(b)(3) is the quiet one. It denies the exclusion entirely if you already excluded gain on another home sale within the two years ending on this sale, which catches owners who downsized shortly before the exchange.

Neither test is satisfied by intent. The IRS looks at where you actually slept and what the deed says, so a family that keeps a second home and stays in the exchange property only in summer will not reach two aggregate years of principal residence.

Each rental year before you move in removes its proportional share of the exclusion

Section 121(b)(5) prorates rather than forgives. Gain allocated to periods of nonqualified use, meaning any period after 2008 during which the property was not the principal residence of you or your spouse, is not excludable, and the allocation is the ratio of nonqualified months to total months of your ownership.

The statutory exception runs the wrong way for an exchanger. Section 121(b)(5)(C)(ii)(I) protects only the part of the five-year window falling after the last day the property was your residence, which is why an owner who lives in a house and then rents it is treated far better than one who rents first and occupies second.

Publication 523 shows both ends. Its Taylor example, resident and then landlord, has no nonqualified use at all; its Finley example, two rental years inside five years of ownership, loses 40 percent of the remaining gain.

Depreciation comes off the top, and the layer you carried in comes off with it

Section 121(d)(6) withholds the exclusion from gain up to "the portion of the depreciation adjustments (as defined in section 1250(b)(3)) attributable to periods after May 6, 1997." That slice is unrecaptured section 1250 gain, taxed at a maximum rate of 25 percent rather than the long-term capital gain rate.

Read the cross-reference. Section 1250(b)(3) defines those adjustments as everything "reflected in the adjusted basis of such property on account of deductions (whether in respect of the same or other property)." A replacement bought in an exchange takes a substituted basis, so the write-offs you claimed on the properties you exchanged out of are reflected in this one.

The sequence is fixed by 121(b)(5)(D): apply (d)(6) first, then prorate what remains without regard to the depreciation gain. Worksheet 3 in Publication 523 runs the same two steps in that order.

A $700,000 sale where the exclusion reaches $180,000 of a $550,000 gain

Hypothetical figures, rounded. You close the exchange on 1 January 2027 into a $500,000 house, rent it at market rent for two years, move in on 1 January 2029, and sell on 2 January 2032 for $700,000 with an adjusted basis of $150,000.

Realized gain is $550,000. Depreciation adjustments after May 6, 1997 reflected in that basis, say $30,000 claimed across the two rental years plus $220,000 carried in from the properties you exchanged out of, come to $250,000 and are ineligible, leaving $300,000.

Two of your five years of ownership were nonqualified use, so 40 percent of that $300,000, or $120,000, remains taxable as long-term capital gain. The $180,000 balance is excluded. You are taxed on $370,000 of a $550,000 gain, five years and a day after the exchange closed.

Change one input and the answer moves sharply. Cut the carried-in depreciation to $20,000 and the excludable figure becomes $300,000, capped at $250,000 on a single return; stretch the rental period to four of seven years of ownership and the nonqualified fraction takes 57 percent of what the depreciation rule leaves.

What the conversion is actually worth, and the order it has to happen in

Converting pays when the appreciation after you move in is large and the carried-in depreciation is small. It pays very little on a third or fourth exchange, where most of the gain is old deferred gain and old depreciation rather than new growth. Confirm the numbers with your CPA or attorney before the tenants leave, because a conversion is hard to unwind.

• Rent the replacement at a fair rental first so the exchange itself survives; how long to rent before moving in covers the two-year safe harbor.
• Move in afterwards and stay put, because the two-year residence test is measured inside the five years ending on the sale.
• Do not list before the fifth anniversary of the exchange closing; 121(d)(10) is all or nothing, not a sliding scale.
• Keep the depreciation schedules for every property in the chain, not just this one, since your preparer needs the whole post-1997 total.
• Count the months of rental use separately from the months of residence; the proration is measured over your entire ownership period, not over the five-year window.