Can a second home or vacation home qualify for a 1031 exchange?
The following 1031 information on this website was graciously provided by Jeff Yonamine of Exchange Resources Inc.
The IRS has recently provided guidance (Revenue Procedure 2008-16) to taxpayers to help determine whether a dwelling unit qualifies as property held for the productive use in a trade or business or for investment under section §1031 beginning on March 10, 2008. This guidance provides a safe harbor under which the IRS will not challenge whether a dwelling unit will qualify for an exchange if certain requirements are met. The IRS specifically addressed vacation homes and indirectly addressed the conversion of a principle residence into qualifying relinquished property prior to an exchange or conversion of a replacement property into a personal residence after an exchange.
A dwelling unit is defined as any real property improved with a house, apartment, condominium or similar improvement that provides the basic living accommodations including sleeping space, bathroom and cooking facilities.
Under the safe harbor, a dwelling unit qualifies for an exchange property if:
1) The relinquished property is owned by the taxpayer for at least 24 months immediately before the exchange and the replacement property is owned for at least 24 months after the exchange, and
2) In each of the two 12-month periods before and after exchange:
a) The taxpayer must rent the property to another person at a fair rental for 14 days or more, and
b) The taxpayer’s personal use of the dwelling unit does not exceed the greater of 14 days or 10% of the number of days during the 12-month period that the dwelling unit is rented at a fair rental.
A few of the factors the IRS considers in determining whether a dwelling unit has been used for personal purposes includes: (1) use by the taxpayer or any other person who has an interest in such unit (including a tenant in common), or by any member of the family of the taxpayer or such other person; (2) use by any individual who used 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); (3) use by any individual if rented for less than fair market value. A taxpayer may rent the dwelling unit to a family member if the family member uses it as a primary residence and pays fair market rent. ‘Fair market rent’ is determined on all the facts and circumstances that exist when the rental agreement is entered into, and all rights and obligations of the parties to the rental agreement are taken into account.
A safe harbor simply provides a way to complete an exchange without being challenged by the IRS on a particular issue. It is very important to understand that a dwelling unit may not meet the guidelines provided under the safe harbor and still qualify under the statutory requirements. However, the IRS indicates those exchanges that do not meet the safe harbor guidelines will be subject to scrutiny.
When considering an exchange, New Standard Realty and Exchange Resources, Inc. highly recommends that the taxpayer seek counsel of their CPA and attorney to obtain professional and legal advice. NSR and ERI cannot and does not provide advice regarding specific tax consequences.
Although I have personally used Exchange Resources Inc on numerous occasions, there are many 1031 facilitators available to choose from.
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