One of the frequent questions we receive from those seeking to complete an exchange in 1031 form is if they are able to make an exchange of 1031 funds from their vacation home (relinquished property) into a comparable qualified home (replacement property) in a tax-deferred basis by using the 1031 exchange?
In the past there have been variety of opinions from 1031 exchange industry experts about whether real estate owned or used for personal purposes like vacation homes or second homes can be exchanged with other similar properties as part of the section 1031 exchange.
IRS Issues Guidelines On 1031 Exchanges Of Vacation Properties & Second Homes
Because of the uncertainty surrounding the potential of this situation, the Internal Revenue Service issued the Revenue Procedure 2008-16. This guidance contains Safe harbor language that clarifies what happens when your vacation property or second residence that was converted into investment property will be considered to be “qualified usage property” and therefore eligible for the 1031 Exchange treatment according the Section 1031 under the Internal Revenue Code.
It is important to note that the Revenue Procedure 2008-16, which began to take effect the 10th of March, 2008 contains several guidelines for safe harbors that will allow investors to complete an 1031 Exchange of a vacation rental or a second residence. It is vital to know that Rev. Proc. 2008-16 is the only the safe harbor language.
A 1031 exchange for the property used for vacation or as an additional home that is outside the safe harbor guidelines could be eligible for tax-deferred swap conditions based on the particular conditions.
Safe Harbor Guidelines For Vacation Homes Or Second Homes That Are Held As Relinquished Property
The purchase of a vacation house is tax-deferred exchanges if the safe harbor requirements have been fulfilled:
The property in question has been held and owned by the owner for at minimum 24 months prior to the date of 1031 Exchange (“qualifying time of use”) and
The property was available for rental at fair market rent rates to other persons for a minimum of 14 consecutive days (or more) in each of the previous two (2) years and
The buyer was able to limit his private use of and enjoyment in the house for no more than 14 days in the two preceding (2) years or 10% (10 percent) of the total number of days the house was actually rent to others during each of the two preceding (2) year.
Safe Harbor Guidelines For Vacation Homes Or Second Homes Purchased As Replacement Property
Purchase of vacation property or second home is tax-free exchange If this safe harbor requirements have been fulfilled:
The property in question is held and owned by an investor at most 24 months following the 1031 Exchange (“qualifying use period”); and
The property was rented for reasonable market rates to non-residents for a minimum of fourteen days (or more) over the next two (2) years; and
The owner limits the enjoyment and use of the property to no more than 14 consecutive days over each of the two (2) years or 10% (10 percent) of the total number of days the house was actually rent to others over the next two (2) years.
Keep in mind that any using the property for the owner or family members will be viewed as personal use by the person. Additionally, any situation where the fair market rent amount is not due to the owner could be considered personal usage of the person investing.
The Final Words
It is essential to carefully analyze each of your transactions in a way that is unique to each transaction with your tax and legal advisors to determine if the specific pattern of fact is compliant with Rev. Proc. 2008-16, or will support the idea that your vacation home or second residence was actually held to be used for investment, rental or business purposes, and would thus qualify for tax-deferred exchange.