This article about using your vacation home or Leavenworth condo in 1031 tax exchange was provided by Ann Mclaren of LandAmerica 1031 Exchange Services. I have been fortunate to take a 1031 class from Ann in the past and I welcome anyone to contact her directly for more details on 1031 exchanges. She can be reached at (866) 962-1031. I hope to have more articles from her in the future.
A vacation home or second home held for personal use, solely for personal enjoyment, is not eligible for 1031 exchange treatment. However, a vacation home that is rented out at fair market value and is never used by the owner or his family is clearly eligible for 1031 exchange treatment. Most vacation properties fall somewhere between these two extremes, with some personal use and some rental use. Until recently, there has little binding guidance on the exchange of vacation properties in 1031 exchanges.
Revenue Procedure 2008-16, which is effective on exchanges occurring on or after March 10, 2008, provides safe harbor rules for vacation homes and properties converted to or from personal residences. If the safe harbor guidelines are met, the IRS will not challenge whether the property qualifies as property held for productive use in a trade business or for investment under Section 1031.
A vacation home or second home that you are selling and/or purchasing in a 1031 exchange will qualify for safe harbor tax-deferred treatment if:
1) The relinquished property is owned by you for at least 24 months immediately before the exchange and the replacement property is held by you for at least 24 month immediately after the exchange.
2) The dwelling unit is rented out at fair market value to another person for 14 days or more for each of the two years immediately before the exchange for relinquished property or two years immediately after the exchange for replacement property.
3) Your personal use is limited to the greater of 14 days per year, or 10 percent of the number of days of the year that the property is rented at fair market value, for two years prior to or after the exchange. You may use the property some additional days for repairs and annual maintenance, but must be prepared to prove actual work done.
Personal use is defined as being used by you, any family member, or anyone who has an interest in your property, such as a tenant in common, or by any arrangement where fair market rent is not paid. You may rent your property to a family member if they use it as a principal residence (not as a vacation home) and pay fair market rent.
Under these safe harbor guidelines you may sell, exchange, or move into your replacement property after you have met the requirements for the first 24 months. 1031 exchanges of vacation properties or second homes that do not follow the safe harbor guidelines in Revenue Procedure 2008-16 may still qualify for 1031 exchange treatment outside of these parameters, but you should be prepared for increased scrutiny by the IRS.
Ann Mclaren, Vice President
LandAmerica 1031 Exchange Services