1031 Exchanges of Rental Properties and Vacation Homes

In a 1031 exchange, no gain or loss shall be recognized on the exchange of real property held for productive use in a trade or business or for investment if such real property is exchanged solely for real property of like kind which is to be held either for productive use in a trade or business or for investment. But do vacation homes and rental properties satisfy those requirements?

Consider the Intent of the Owner

The relinquished property must be held for a qualifying purpose, e.g., investment / business. It has been said that one must have had the "intention" to hold the property for investment purposes at the time of the sale; and that it is the taxpayer's responsibility to demonstrate the requisite intent (to hold the property for productive use in a trade or business or for investment) at the time of the exchange. 

In Rev Rul 57-244, 1957-1 CB 247, the IRS held that a residential property could be changed to qualified exchange property if the taxpayer actually altered or transformed the use of the property. However, simply renting out a personal residence will not automatically qualify it for tax-deferred exchange treatment.

Here is an excerpt from a tax treaties that is somewhat on point but deals more with the holding of the new replacement property:

• The property received in the exchange must also be held for investment or in the taxpayer's trade or business. It is not clear how long such property must be held. The phrase "to be held for" in I.R.C. § 1031(a) implies a continuity of ownership. A subsequent disposition of the property received may be evidence that the property was not acquired for investment or use in the taxpayer's business.

What if the Property has Been Held a Very Short Time Before it is Exchanged? 

For example, if X received a distribution of a building from a partnership and immediately exchanges it, has X met the "held for" requirement?  See Bolker v. Commissioner, 760 F.2d 1039 (9th Cir. 1985), aff'g, 81 T.C. 782 (1983) (the court allowed a I.R.C. § 1031 exchange where the real estate transferred had just been received in connection with a liquidating distribution from a corporation); the court held that the requirement that the realty be held for investment was satisfied as it was not acquired in the liquidation with the intention of liquidating the realty or using it personally. 

What if the Taxpayer Wishes to Conduct an Exchange Involving a Vacation House? 

In Rev. Proc. 2008-1, C.B. 585, the IRS provides a safe harbor for whether a dwelling unit, including a vacation property, will be considered property held for productive use in a trade or business or for investment.

Please check with your CPA about the matter and if they would require additional rental history and tax reporting consistent with use as a rental property (rather than personal use).

• Start Your 1031 Exchange: If you have questions about 1031 exchanges, feel free to call me at 612-643-1031.

Defer the tax. Maximize your gain.

© 2021 Copyright Jeffrey R. Peterson All Rights Reserved

What to Know About 1031 Exchanges of Vacation Homes

For years tax controversies have stemmed from taxpayers selling their highly appreciated vacation/second homes. The problem has been that these "personal use" vacation-properties have fallen outside of the favorable tax treatments that many other real properties qualify for.

Vacation Homes

First, vacation homes normally do not qualify for the Section 121 Principal Residence Exclusion (provides an exclusion of up to $500,000 of gain for married persons filing a joint return / $250,000 of gain for single persons) because the property has not been used as the taxpayer's primary residence for two of the past five years. Second, despite the fact that many taxpayers feel that their second home or vacation condo is one of the best "investments" they ever made, and should qualify for tax deferral under Section 1031 (provides for non-recognition or deferral of capital gains tax for exchanges of properties held for "Investment" or for use in a "Trade or Business"); the IRS does not agree that these "personal use" type properties qualify for 1031 exchange treatment.

The IRS takes the position that vacation homes are held primarily for personal use rather than for investment. In May of 2007, the IRS successfully convinced the Tax Court that a taxpayer's exchange of a lake-side vacation home for another did not qualify as a 1031 exchange despite the taxpayer's expectation that the property would appreciate in value and could eventually be sold at a gain; Moore v. Commissioner, T.C. Memo. 2007-134.

SAFE-HARBOR

As a matter of administrative ease or convenience, the IRS has laid down a new safe-harbor for vacation home owners. Revenue Procedure 2008-16 gives owners who primarily rent out their vacation homes, but still occasionally use them for some personal use, a safe harbor to qualify for 1031 tax deferred treatment. Revenue Procedure 2008-16 requires that both the "relinquished property" that is sold and the "replacement property" that is purchased, must be used by the taxpayer consistent with a Qualifying Use Standard:

• TWO YEAR "OWNERSHIP" TEST: The taxpayer must have owned the vacation home for least 24 months immediately before the exchange;

• "USE" TEST FOR EACH OF THE PRIOR TWO YEARS: The taxpayer must have within each of the prior two 12-month periods immediately preceding the exchange:

  • (i) rented out the vacation home to another person or persons at a fair rental for 14 days or more, and (ii) not used the vacation home for personal use for more than 14 days; or more than 10 percent of the number of days during the 12-month period that the vacation home was actually rented at a fair rental.

A similar Qualifying Use Standard must be applied to any vacation home replacement properties. The taxpayers may take only limited personal use of their rented replacement properties for the 24 month period after completing their 1031 exchange into a vacation home.

Section 1031 has a very broad "like-kind" standard for real property. Generally, any real property within the United States that is held for "Investment" or for use in a "Trade or Business" can be exchanged for other US real property that will also be held for "Investment" or for use in a "Trade or Business".

Raw land may be exchanged for improved real property. Commercial property may be exchanged for residential rental property. Undoubtedly, many taxpayers who have grown weary of property management will consider purchasing vacation homes to be placed into a rental pool with the fringe benefit of occasional personal.

A smart taxpayer desiring more recreation might consider exchanging into multiple vacation home replacement properties. Each property would have a separate 14 day/ 10% personal use allowance. This is more advantageous than buying only one vacation home replacement property that would allow for less personal usage.

Real Estate Exchanges Under Section 1031

Under section 1031 of the Internal Revenue Code, taxpayers are able to defer their taxes when selling real property as long as they re-invest their net proceeds into replacement property. There are many rules and regulations you need to follow in a given exchange so it’s important to work with a qualified intermediary. Reach out to our 1031 exchange professionals today to talk about the details of your like-kind exchange. We work with taxpayers throughout the state of Minnesota and across the United States.

• Start Your 1031 Exchange: If you have questions about 1031 exchanges, feel free to call me at 612-643-1031.

Defer the tax. Maximize your gain.

© 2020 Copyright Jeffrey R. Peterson All Rights Reserved

Tips for Qualifying Your Vacation Property for 1031 Exchange

Many investors wonder whether or not their vacation property qualifies for 1031 exchange. The answer is – it depends. Vacation property can qualify for 1031 exchange, but there are strict benchmarks you must hit in order for it to qualify. In this article, we are going to offer up some tips for qualifying your vacation property for 1031 exchange treatment.

How to Prepare Your Vacation Property for a 1031 Exchange

If you’ve got a vacation home that you want to convert into a rental property in preparation for an eventual 1031 exchange, here are some tips for doing so:

• Lease the vacation property as much as possible and keep written records of all leasing activities.

• Restrict your personal use of the property to a minimum. The benchmark for 1031 exchange is that the property can only be used personally for less than two weeks per year, or less than 10% of the days that the property is rented.

• List the property on popular rental websites like VRBO.

• Hire a property management company to manage the rental of the property.

• Show rental income and expenses on Schedule E of the property owner’s tax return.

CPEC1031 – Minneapolis, MN

CPEC1031 – based in Minneapolis, MN – is your one stop shop for all things related to 1031 exchanges. With two decades of experience facilitating exchanges across multiple industries, our qualified intermediaries are well-equipped to help you navigate the details of your 1031 exchange. Reach out to our 1031 exchange professionals today to set up your like-kind exchange. Our main office is in downtown Minneapolis, but we work with clients throughout Minnesota, as well as across the United States.

• Start Your 1031 Exchange: If you have questions about 1031 exchanges, feel free to call me at 612-643-1031.

Defer the tax. Maximize your gain.

© 2019 Copyright Jeffrey R. Peterson All Rights Reserved

3 Benefits of a Like-Kind Exchange

There are many benefits of performing a like-kind exchange of real estate instead of selling your property in a typical transaction. In this article, we’re going to offer three benefits of deferring taxes with a like-kind exchange of real estate.

Avoid a Tax Bill

The most obvious benefit of conducting a like-kind exchange of real estate is the ability to defer your taxes on the sale of real estate. In a typical real estate sale, the seller has to pay capital gains taxes on the net proceeds from the sale. In a 1031 exchange, you can defer those capital gains taxes and avoid a huge tax bill. To do this you must move all of your net proceeds into new replacement property. In doing so, you avoid a tax hit and keep your money compounding wealth over time.

Diversify your Real Estate Portfolio

1031 exchanges are also a great way to diversify a real estate portfolio into different asset classes, alternative market segments, and geographical areas.

Selling Vacation Homes

Vacation homes can also be exchanged in 1031 exchange transactions. That being said, there are some additional restrictions on 1031 exchanges of vacation homes. For more information on 1031 exchanges of vacation homes, check out this article.

MN Qualified Intermediary

At CPEC1031, our MN qualified intermediaries have decades of experience facilitating real estate exchanges for clients large and small. 1031 exchanges are complex. You need an intermediary on your team who can simplify the process for you. Our intermediaries will prepare all of your 1031 documents, advise you on replacement property, and answer all of your questions along the way. Contact us today to discuss the details of your like-kind exchange and how you can defer your taxes and maximize your gain.

• Start Your Exchange: If you have questions about 1031 exchanges, feel free to call me at 612-643-1031.

Defer the tax. Maximize your gain.

© 2018 Copyright Jeffrey R. Peterson All Rights Reserved

1031 Exchanges of Vacation Homes

Vacation homes have been a hot button issue for the IRS when it comes to 1031 exchanges. They have challenged the exchange of second homes, cabins, ski chalets, and the like. Their position is this: if the taxpayer uses the property primarily for personal use, it doesn’t matter that the taxpayer wanted it to appreciate in value and was hoping it was a good investment. What matters is the taxpayer’s use of the property. In short, you can’t exchange a cabin for another cabin if both properties are used for personal use.

Moore v. Commissioner

The seminal case in this area is Moore v. Commissioner. In 2008 the IRS went out of their way to create a safe harbor because a lot of taxpayers like to own vacation condos that are put into rental pools managed by companies that bring in periodic tenants. But the taxpayer may also want to use their condo for a few weeks a year.

So the IRS decided to look at the properties you sell in a 1031 and analyze the two years prior to sale to determine if it was used too much for personal property. They test each of those years to see if the taxpayer used it more than 14 days a year or more than 10% of the time it was rented. If you stay within the confines of this safe harbor, you can still do a 1031 exchange provided it was in a rental pool and your use didn’t exceed these thresholds.

Exchanging into a Vacation Home

The same analysis also applies if you’re exchanging into a property that is going to be put into a rental pool. On the replacement side, if you’re buying a condo you want to make sure that your personal use does not exceed 14 days a year, or 10% of the time it was rented.

Here’s a tip - don’t be cute with the IRS. If you’re going to go on vacation for a month and a half, rent a different condo than the one you own. Then you can avoid this common trap when it comes to 1031 exchanges of vacation homes.

• Start Your Exchange: If you have questions about 1031 exchanges of vacation homes, feel free to call me at 612-643-1031.

Defer the tax. Maximize your gain.

© 2016 Copyright Jeffrey R. Peterson All Rights Reserved