SETTING UP A VACATION HOME 1031 EXCHANGE
UNDERSTAND IF YOU QUALIFY FOR A VACATION HOME 1031 EXCHANGE
VACATION HOME 1031 EXCHANGES
DOES YOUR VACATION HOME QUALIFY FOR a TAX DEFErred Exchange?
By definition, vacation homes are typically held for personal use. Generally, vacation homes are in a vacation destination away from your main home. As a result, tax professionals commonly declare it for personal use. Common reasons are being in a warm weather location, recreational uses, and no mentions of investment activity.
What if you rent or try to rent your property when it's vacant? Does your property qualify? Section 1031 does not define investment. Although, Code Section 280 states presents guidelines for renting out the property. Section 280 states that using the property more than 14 days of the year or 10% of the time rented means that you cannot deduct the loss associated with operating the unit.
There is no clear path between the two code sections, 1031 and 280. However, the IRS tried to define investment activity within section 280, and may lean on it during an audit. So how can you qualify your vacation home for a 1031 exchange? How you handle your investment property expenses on your tax return may determine if your property qualifies as investment for a 1031 exchange. As an example we have two relevant court rulings below to provide guidance. Additionally, we explain the Safe Harbor Rule for Vacation Home 1031 Exchanges.
INVESTMENT PROPERTY QUALIFICATION COURT RULING GUIDANCE
RIVERA v. COMMISSIONER (2004)
The taxpayers in this case used the property for personal use and never rented the property. The court ruled for the taxpayer allowing the exchange based on testimony they purchased the property with the expectation it would increase in value. This argument satisfies the investment criteria of 1031 per the court.
MOORE v. COMMISSIONER (2007)
The taxpayers used the property personally over four months per year. They kept the property vacant for the rest of the year. The taxpayers never rented it, and personally deducted all of the expenses on their tax return. The taxpayer testified they bought the property expecting it would increase in value as in Rivera, but the court challenged and determined the property was held personally, disallowing the exchange. The court said if they handled the expenses differently on their tax return, they might have agreed.
(T.C. Memo 2007-134, 5/30/07),
SAFE HARBOR RULE FOR VACATION PROPERTY 1031 EXCHANGES
Revenue Procedure 2008-16, effective march 10, 2008
The Safe Harbor Rule provides a number of guidelines that permit you to complete a 1031 of your vacation property or second home. It is important to note that Rev. Proc. 2008-16 only provides safe harbors and that a 1031 exchange of a vacation home or second home that falls outside of the safe harbor guidelines may still qualify for a 1031.
Safe Harbor Rule Requirements
The relinquished and replacement property is held for at least 2 years prior to the exchange for the old property, and 2 years after the exchange for the new property.
The property is rented out for at least 14 days each year at fair market value.
Used for personal use for no more than 14 days or 10% of the total amount of days rented per year (i.e. if one year the property is rented out for 200 days, the taxpayer may use it personally for no more than 20 days in that same year)