Can Exchange Proceeds Be Used To Acquire A Personal Residence?

The only kind of real property that doesn't qualify for 1031 treatment is personal use property, including primary and second residences.

However, if a second residence is called an investment or vacation rental property, it would qualify.

 
A new property you are planning to acquire could qualify as a suitable replacement for the current property only if you acquire it for the purpose of renting it out, using it for a business, or as an investment.  If you acquire it with the intention of residing in it right away, it will not qualify and the gain on the first property will be taxable.

If your ultimate goal is to live in the new property, you can acquire it as a rental, rent it out for several months in order to satisfy your 1031 replacement requirement, and then later convert it into a personal use property (moving into it).  There is no statutory minimum time for rental use. However, the longer the better.  It is also not a good idea to tell anyone of your plans to convert it to personal usage ahead of time.  IRS has to believe that your intended use for the new property is not as a personal residence. 

As of October 23, 2004 there is a new twist to the issue of selling residences that had originally been acquired as 1031 replacement property.  If it is sold in less than five years after originally being acquired, the seller may not use the Section 121 exclusion of $250,000 or gain per person.   You can see more discussion of this new law on Kerry's blog.

KMK