Short term rentals are big business up here in the mountains and a lot of folks want to know how to use the 1031 exchange program to purchase a vacation home. If you are asking what the heck is a 1031 exchange program? Well to summarize without getting into to much depth, the 1031 exchange program allows the deferral of the gain from one investment property into another. The tax court has ruled that properties held strictly for personal enjoyment do not qualify for this program. The big question is, "Are vacation homes held for investment, or for personal enjoyment?" The thing to do then is to differentiate your property from purely personal enjoyment, and cast it, or document it, as investment property.
Here is some guidelines that will help you differentiate between the two:
Up here in the mountains of North Georgia most folks use a property manager to handle all the aspects of owning a short term rental home. They take anywhere from 25% to 30% of the earnings that comes from the rentals. There is also on-line leasing services which have proven to be an effective way to manage the leasing of this property from a distance.
Record keeping is very important so if you use the online leasing service you can keep a copy of the inquiries, and all your responses, in a separate email folder. This will prove that you sincerely have tried to rent the property. You should also keep a calendar of the dates that you use the property, and whether you used the property for enjoyment or for maintenance. You can also use the property for business where you can meet your clients or customers for a meeting.
So on your calendar, it reflects the dates that you used the property and whether you used it for enjoyment, maintenance or business. Keeping the enjoyment days to less than 14 days a year, and making sure the maintenance days are reasonable. The IRS will allow you 14 personal enjoyment days, as well as a reasonable number of maintenance days a year.
Example: Use the property for 10 to 14 personal days, two to four maintenance days, and 7 to 14 business days a year. The rest of the time it's either rented, or available for rent.
When tax time comes around consult your CPA for the details but you will file a Schedule E for this property with your tax return. Schedule E is the form that reports income and expenses (including interest & taxes) from rental property. The IRS is very formal about this, and they assume that if the property were truly an investment property you would have filed a Schedule E.
Depreciation is required for rental property, but not allowed for personal enjoyment property. It's another one of those things that differentiates how the IRS views the property.
It is really good that you have a separate bank account for your rental property and its probably not a bad idea to have a separate account for each rental. You don't want to run the income and expenses for your rental property through your personal accounts.
When it comes time to sell and you want to use the 1031 exchange program assume that you'll get audited, so do things correctly from the beginning. The difference between being able to do an 1031 exchange and deferring the tax, or having to pay tax on the sale of your vacation home depends upon your willingness to follow the right steps.
Check out this great community in the North Georgia Mountains called Highland Falls Cabins and give me a call if you like what you see: http://www.highland-falls.com/
Make It a Great Day!
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