Does a Vacation Home qualify for 1031 Exchange?

[Celia Moore]

The answer is “yes” if the dwelling meets the qualifications set forth in Revenue Procedure 2008-16. Effective March 10, 2008. This revenue procedure clarified what was once considered a muddled area of 1031 exchanges. The qualifications are the following:

Relinquished property

1. The holding period for the vacation home is at least 24 months immediately before the exchange*;
2. For each of the two-12-month periods, the vacation home is rented to another person at a fair rental for 14 days or more; and
3. The homeowner limits his use of the vacation home to not more than 14 days or 10% of the number of days during the 12-month period that the vacation home is rented at a fair rental value.

* For this purpose, the first 12-month period immediately preceding the exchange ends on the day before the exchange takes place (and begins 12 months prior to that day) and the second 12-month period ends on the day before the first 12-month period begins (and begins 12 months prior to that day).

Replacement property

1. The holding period following the exchange is at least 24 months*;
2. For each of the two-12-month periods, the vacation home is rented to another person at a fair rental for 14 days or more; and
3. The homeowner limits his use of the vacation home to not more than 14 days or 10% of the number of days during the 12-month period that the vacation home is rented at a fair rental value.

* For this purpose, the first 12-month period immediately after the exchange begins on the day after the exchange takes place and the second 12-month period begins on the day after the first 12-month period ends.

Here’s an example to analyze this revenue procedure. Let’s assume that taxpayer has owned a beach home since July 4, 2002. The taxpayer and his family use the beach home every year from July 4, until August 3 (30 days a year.) The remainder of the year the taxpayer has the house available for rent. Now, the taxpayer has negotiated the sale of his beach home so that ownership of the house transfers on May 5, 2008. Under the Revenue Procedure, the IRS will examine two 12-month periods: (1) May 5,2006 through May 4, 2007 and (2) May 5, 2007 through May 4, 2008. To qualify for the 1031 exchange, the taxpayer was required to limit his use of the beach house to either 14 days (which he did not) or 10% of the rented days. So, the IRS will need to find that the taxpayer actually rented the house at a fair market value for 300 days each during the two 12 month periods for the vacation home to qualify for a 1031 exchange.

As always, your CPA and/or attorney can advise you on this tax issue.

For more information head online now to 1031exchange.com!