1031 Like-Kind Exchanges of Vacation Homes and Second Homes

One of the questions we get from individuals looking to do a 1031 exchange is whether they can do a 1031 exchange out of their vacation homes (relinquished property) into another qualified like-kind property (replacement property) on a tax deferred basis using a 1031 exchange?

Over the years, there has been a myriad of opinions by 1031 exchange industry experts on whether real property held or used for personal use such as vacation home and second homes could be exchanged for other like-kind properties under the section 1031 exchange.

IRS Issues Guidance on 1031 Exchanges of Vacation Properties & Second Homes

Due to the confusion regarding the possibility of this issue, The Internal Revenue Service issued the Revenue Procedure 2008-16. This guideline provides Safe harbor language that clarifies when your vacation home, second home that was converted to investment property would be considered as “qualified use property” and therefore qualify for 1031 Exchange treatment pursuant to Section 1031 of the Internal Revenue Code.

The Revenue Procedure 2008-16, which became effective on March 10, 2008, provides a number of safe harbor guidelines that would permit an investor to complete a 1031 Exchange of a vacation property or a second home. It is important to note that Rev. Proc. 2008-16 only provides safe harbor language.

A 1031 Exchange of vacation property or a second home that falls outside of the safe harbor guidelines may still qualify for tax-deferred exchange treatment depending upon the circumstances.

Safe Harbor Guidelines for Vacation Homes or Second Homes Held as Relinquished Property

The sale of a vacation home will be eligible for tax-deferred exchange if the following safe harbor requirement has been met:

  • The subject property has been owned and held by the investor for at least 24 months immediately preceding the 1031 Exchange (“qualifying use period”); and
  • The subject property was rented at fair market rental rates to other people for at least 14 days (or more) during each of the preceding two (2) years; and
  • The investor limited his or her personal use and enjoyment of the property to not more than 14 days during each of the preceding two (2) years, or ten percent (10%) of the number of days that the subject property was actually rented out to other people during each of the preceding two (2) years.

Safe Harbor Guidelines for Vacation Homes or Second Homes Purchased as Replacement Property

The purchase of a vacation home or second homes will be eligible for tax-deferred exchange if the following safe harbor requirement has been met:

  • The subject property is owned and held by the investor for at least 24 months immediately following the 1031 Exchange (“qualifying use period”); and
  • The subject property was rented at fair market rental rates to other people for at least 14 days (or more) during each of the following two (2) years; and
  • The investor limits his or her personal use and enjoyment of the property to not more than 14 days during each of the following two (2) years, or ten percent (10%) of the number of days that the subject property was actually rented out to other people during each of the following two (2) years.

Remember that use of the property by the individual or their family members will be considered as ‘personal use’ by the individual. Also, situations whereby fair market rent value isn’t paid to the investor will also be regarded as personal use by the investor.

Final Thoughts

You must carefully analyze and evaluate each of your transactions on a case-by-case basis with your legal and tax advisors to determine if your specific fact pattern complies with Rev. Proc. 2008-16 or would support a position that your vacation property or second home was in fact held for rental, investment or business use and would therefore qualify for tax-deferred exchange treatment.

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