A DST 1031 exchange is a method by which you can avoid capital gains tax for exchanging one piece of real property for another piece of real property. It's an exceptionally useful financial tool, but it does come with some restrictions.
What Is a DST 1031 Exchange?
Under a DST 1031 exchange, you use an escrow company to transfer the value of your current property to a new property. To qualify for an exchange, you can never have control of the funds that are made available through the sale of the initial property. Frequently, a DST 1031 exchange is used to exchange rental properties.
With this type of exchange, you can sell a rental property and use the full proceeds to purchase a similar rental property, without paying taxes on the gains that you made from the initial property. That can save a significant amount of money, especially if you've held the initial property for some time.
Can You Use a DST 1031 Exchange on Your Primary Residence?
In general, no — but it's important to understand why. A DST 1031 exchange doesn't apply to primary residences and it generally doesn't have to. Unless your property is worth quite a lot (the limits are set by state), you probably won't need to pay any capital gains at all. A significant amount of capital gains are sheltered when you're selling a primary residence.
Thus, the reason that you can't use a DST 1031 exchange for primary residences (such as when upsizing or downsizing your home) is that you really don't need to.
Are There Exceptions to This Rule?
In fact, there are. You can use a DST 1031 exchange for a portion of your primary residence that you use for business, and that's where it gets tricky. If you have a workshop that you run a business out of on your property, you can do an exchange for that portion of your property, which could be substantial.
Again, to complete this exchange you need to do it through an escrow company, so you should intend on doing this from the start. And since it needs to be a like-kind exchange, you would have to be purchasing a property that also had a comparable business area.
So, while you can use a DST 1031 exchange for your primary residence, it's rare. You should contact professional DST 1031 services if you're considering it.
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