The IRS prohibits using a 1031 exchange for the purchase of a new home. However, there is an exception to that rule. If the investor rents out a home for more than a year following the exchange, or simply limits their own personal use for more than a year, that house can then be converted to the investor's place of residence, since the home was initially used to fulfill the stipulations of a 1031 exchange.  It doesn't have to actually be rented the whole time, but it must be offered for rent at market rate for comparable properties, or not be used for personal use.   The idea behind it being rented more than a year is that it goes through two cycles as a rental property on your income taxes.   The IRS doesn't define the holding period, but less than one year will not work in most (if not all) cases.

After five years from the date of the new home's purchase, that home can then be sold and the taxes excluded, due to an IRS exclusion for the sale of a primary residence, which can be $500,000 for married couples and $250,000 for an individual under IRS tax code IRC121.

In my market, where second homes are prevalent and "Baby Boomers" are looking to retire in large numbers, this is an attractive alternative to buying more rental property to complete an exchange.  Vacation and second home properties have appreciated 17% in the last year  making them a very attractive place to put some money.  By combining IRC 1031 and 121, you can not only defer capital gains, you can make them go away completely if you follow the rules laid out by the IRS.  

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