In a Section 1031 exchange, you change one property held for investment for another. The gain that you realize on the exchange is deferred into the cost of the replacement property. If you later sell the replacement property, you pay tax on the deferred gain plus the appreciation in the replacement property. It's a good deal because you can continually trade up for bigger property using the equity in the relinquished property without paying income taxes.
If you change the use of the replacement property into personal use, you run the risk of the Internal Revenue Service disallowing the Section 1031 exchange. This would mean that you would pay tax on the exchange in the year of the exchange since you did not trade for investment property.
Unfortunately, there is no safe harbor for determining when you can convert the investment property to personal use without running the risk of losing the exchange benefits. The key is to maintain the investment status at least for a few years, so that the IRS cannot interpret your move as part of a preconceived plan.
