1031 Exchange: How to Determine if Your Vacation Home Is Eligible

You own a vacation home in Florida, and thinking about trading it up for a property in California when someone gives you the idea to 1031 Exchange your vacation home for another property. The section 1031 of the IRS code allows tax deferment on investment property when it is exchanged for another investment property. Sounds like a great plan, but the only catch is your vacation home may not qualify as an investment property. Here are a few questions to ask yourself if your vacation home can qualify for a 1031 Exchange.

What Was Our Intent?
The IRS is concerned with your intention to use the vacation home when it was initially purchased. Since personal enjoyment of the property blurs the line between personal property and investment property, the IRS has to make a determination as to which is the home’s main purpose. In Moore v. Commissioner, two property owners exchanged vacation homes, of which neither had been rented out. The owners claimed that their properties met the 1031 requirements since they bought the properties with the intent that values of the home would eventually appreciate. Since their home values did appreciate, this constituted them as investments. The IRS disagreed and in 2008, the IRS provided more guidance on how to classify a vacation home.

Do We Meet the Safe Harbor Provision?
The court held that the expectation that a vacation home may be sold at a gain does not justify an investment intent. Revenue Procedure 2008-16 established the safe harbor guidelines that state: (1) you must have owned your vacation home (relinquished property) for 2 years or more and (2) during the past 2 years you have rented the property for at least 14 day or more at fair market value and your use of the vacation home does not exceed 14 days or 10 percent of the days the property was rented. Renting the home out to a family member counts only if at fair market value and the property was used as their primary home.

Can We Provide Proof?
Even if your home doesn’t fall within these safe harbour requirements it still may be eligible. The IRS will look at other factors to determine the intent for the home, such as:
 • Can the intent to use the property as an investment be proven? (There needs to be greater evidence than expectations of appreciation.)
 • For what length of time has the investor owned the property?
 • Is the property being used to generate income?
 • How well has the home been maintained?

If you can substantiate that your vacation home is truly intended for investment, but doesn’t meet safe harbor requirements, be prepared to provide documentation. The more you can prove the property was treated as investment, the better your chances for the 1031 exchange. This includes consistent rental activity and scheduled maintenance. Also, be sure to itemize your vacation home on Schedule E for your annual tax returns. It is best to limit your personal use of the property as much as possible.

blog comments powered by Disqus