Can You Do a 1031 Exchange on a Vacation Home? Can You Do a 1031 Exchange on a Vacation Home?
In short the answer is yes, but of course there are some caveats. To determine whether your vacation property qualifies for a 1031 exchange, you’ll need to consider how long you’ve owned the property, how often you stay at the property, and how often you’re renting the property out. Below we’ll get into the details outlined in Revenue Procedure 2008-16 that cover whether a vacation property qualifies for a 1031 tax-deferred exchange.
For investors hoping to mitigate capital gains taxes while having some personal use on a property involved in a Section 1031 Exchange, Revenue Procedure 2008-16 checks all the right boxes.
Revenue Procedure 2008-16 may provide a safe harbor for certain exchange transactions that involve property used for personal use. In summary, the IRS has approved investors to classify property as real estate held as a vacation home so long as the property is held for productive use in a trade or business or for investment. Owners must abide by the strict rules outlined in Rev Proc 2008-16 coupled with IRC 1031 as outlined below.
What are the Qualifications?
The IRS will not challenge whether a dwelling unit (real property that provides living accommodations) qualifies under a §1031 exchange as property held for productive use in a trade or business or for investment if the dwelling unit meets the following qualifying use standard:
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The dwelling unit is owned by the taxpayer for at least 24 months immediately before the exchange for a property that a taxpayer intends to be relinquished property or immediately after the exchange for a property that a taxpayer intends to be replacement property (the “qualifying use period”), and
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In each of the two 12-month periods constituting the qualifying use period:
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The taxpayer rents the dwelling unit to another person or persons at a fair market value for 14 days or more; and
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The taxpayer’s personal use of the dwelling unit does not exceed the greater of 14 days or 10 percent of the number of days during the 12-month period the dwelling unit is rented at a fair market value.
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We classify this as the 2-2-2 Rule: own for two years, rent for two weeks, personal use for two weeks or 10% of the rental time.
Under the Revenue Procedure, personal use of a dwelling unit occurs on any day in which the taxpayer is deemed to use the property for the following personal purposes: (A) use by the taxpayer or any other person who has an interest in the unit or by a family member; (B) use by any individual who uses the unit under an arrangement which enables the taxpayer to use some other dwelling unit (whether or not a rental is charged for the use of such other unit); or (C) use by other individuals if rented for under fair market value. A taxpayer can rent the property to a family member if the family member pays fair market value.
Whether a dwelling unit is rented at a fair market value rate is determined based on all the facts and circumstances that exist when the rental agreement is entered into. All rights and obligations of the parties to the rental agreement are taken into account.
Should the taxpayer abide by the above regulations, the property will qualify as a relinquished or replacement property under a §1031 exchange. Please consult your tax or legal counsel for all specifics concerning your tax consequences.
If you have any questions about Section 1031 of the Internal Revenue Code, IRS Revenue Procedure 2008-16, how this procedure provides a safe harbor for certain exchange transactions, or need help meeting any Qualified Intermediary needs please don't hesitate to reach out to the Leader1031 team!
