Holiday rentals 1031 Exchange

We are often asked if the tax liability for the sale of a vacation home can be deferred using IRC section 1031 procedures. The answer to this question is found in Income Procedure 2008-16.

The general rule of thumb for ALL 1031 exchanges is that the property should be kept primarily for investment or commercial or business use. To show that your vacation home is being held primarily for investment and therefore 1031 eligible, rather than for your personal use, the Internal Revenue Service (IRS) set specific parameters for you to follow. This is known as a “safe harbor”. Those parameters are:

For the old or relinquished vacation property, you must have:

Owned the property for at least two years, and;

In each of those two years, the property must have been rented for 14 days or more at a fair market price.

For new or replacement vacation property

Owned the property for at least two years, and;

In each of those two years, the property must have been rented for 14 days or more at a fair market price.

In addition to these “safe harbor” requirements, there are additional requirements:

Your own use of the 1031 exchange vacation homes must not exceed 14 nights or 10% of the days rented per year, whichever is less, but excluding time spent on the property for repair and maintenance.

The term “safe harbor” means that the IRS will not dispute your 1031 tax deferral claim if you can prove these facts. The burden of proof always falls on the taxpayer. If you 1031 swap vacation homes and you can’t prove these accurate facts, your 1031 swap may still be honored. But it will be subject to increased scrutiny by the IRS. When you do not meet the “safe harbor” test, you can still demonstrate your investment intent through other facts and circumstances. Some of the best ways to demonstrate investment intent are:

Keep an analysis of the investment potential of the property when you buy it. Market trends and resale potential are important parts of this analysis,

Schedule your vacation home on your tax return under your Schedule E,

Take the depreciation

Show property income,

Keep track of your personal use time and remember that time spent on repair and maintenance does not count as personal use time.

Make improvements to the property that maximize your investment potential,

Do not include the property on Schedule A of your tax return.

Showing why you sold the property in less than two years makes sense from an investment point of view.

Note that when advanced planning is possible, most taxpayers convert their personal-use vacation property to property that is held primarily for investment under the aforementioned safe harbor rules prior to conducting a 1031 exchange. A Second home can be converted to investment property, changing the character by placing the property in a rental pool, reducing personal use, and itemizing the property on Schedule E on the tax return.

Vacation properties held on a 1031 exchange can be converted to a primary home, in which case you could qualify for tax exemption under IRC section 121. A second home can be converted into an investment property, changing the character by placing the property in a rental pool. , reducing personal use and itemizing the property on Schedule E on the tax return.

All other Section 1031 exchange requirements apply to vacation home exchanges.

By,

Steven Hickox ESQ

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