Can you do a 1031 Exchanges on Vacation Home?

Taxpayers wanting to defer taxes on a vacation home through a Section 1031 like-kind exchange have contended with incomplete guidelines for many years. A 1031 Exchange allows taxpayers to sell "business or investment" property and purchase replacement property within the current regulations and have the opportunity to defer or eliminate all the Federal and State Taxes. The current tax law will only allow you to use Section 1031 for assets "held" either "for use in a trade or business" or "for investment." Property that is held for personal use like a pure second home usually did not qualify. On February 15, 2008, the IRS released Revenue Procedure 2008-16.

The IRS has never given guidance on how to handle these dual properties that have both personal and investment use. Most vacation homes were rented, but no one knew how much personal use was allowed.

With Revenue Procedure 2008-16, the IRS will allow a vacation home to qualify for a Section 1031 exchange if the following conditions are met:

For the relinquished property

• You have owned it at least 24 months before the exchange
• In each of the two 12-month periods prior to the exchange the property has been rented at fair value for 14 days or more
• The taxpayer's personal use of the property during the prior two 12-month periods doesn't exceed the greater of 14 days, or-10% of the number of days during the periods that the property is rented at a fair rental rate.
  

As with any 1031 exchange the replacement property must also qualify for business or investment property test. The new Revenue Procedure will allow the property to qualify for 1031 exchange if the property it is held for at least 24 months after the exchange. Also the personal use and rental for the two 12 subsequent 12 month periods meet same 14 day/10% test that hold for the property given up.

Please note that the Revenue Procedure is a just a Safe Harbor or guideline. The Safe Harbor means that if you follow these rules your exchange will not fall under IRS scrutiny. If you do not meet these rules exact it does not preclude your exchange from qualifying.

If you would like more information about these new rules please feel free to call myself or Theresa Knower for more information.

Dave Owens, CPA is the Managing Member of 1031 Tax Strategies, LLC with offices located throughout Florida and now Downtown Chicago.