Are you planning to buy or sell a vacation home practicing a 1031 tax-deferred exchange? It is a great idea provided the guidelines are followed properly. Let’s review the ins and outs needed.
Personal Use Basics
To attempt a 1031 exchange on any property, both the relinquished and the replacement properties must be used in a trade or a business or for investment purposes. Let’s understand how to make a vacation home eligible, which ideally have varying levels of usage.
What matters is whether any investment intentions were or will be executed involving the properties in question. Also, personal use is not just limited to you as a taxpayer but extends to your family members, others with stake in the unit (and their families), anyone using the property while you live elsewhere (even if you don’t impose rent), or anyone in case you are renting the property below the fair market value.
Can I Use My Vacation Property?
For a rental property to be eligible for a 1031 exchange, the exchanger cannot use the property for more than 14 days per year.
Many taxpayers assume that their vacation property will be approved for 1031 exchange by merely proving the expectation of appreciation on the property; however, this isn’t enough. No attempt to rent the property, no deductions claimed for depreciation or maintenance, and other factors which display signs not parallel to an investment intent can cause troubles.
IRS Safe Harbor
IRS Revenue Procedure presents a safe harbor clause, meaning that the IRS will not dispute whether a property qualifies as an investment provided the right guidelines are observed using like-kind exchanges. There are a few ways to manage these exchanges outside the safe harbor procedure, but you’ll be at the risk of scrutiny by the IRS.
Following are the safe harbor requirements for a vacation home-
• Meet ownership requirements
• Personal use of the property limited to 14 days per year or 10 percent of the rental period
• Rental to an unrelated party for a minimum of 14 days per year
• Property to be treated as an investment – maintenance of the property, deduction of maintenance and depreciation expenses, utility payment, insurance, and more. If you have a mortgage on the property, ensure it’s an investment loan and not a primary residence mortgage – this can get you disqualified.
How do Properties Qualify?
The guidelines for both the replacement and the relinquished property are as follows:
• Properties must be owned by the investor for two years preceding the exchange.
• In both the years before the 1031 exchange, the investor needs to rent the property for a minimum of 14 days at fair market value and shouldn’t use the property for any sort of personal use for either 14 days or 10 percent of the rental period, whichever is greater. Also, remember that personal use doesn’t limit to you; instead, it includes family members and other individuals also.
For more on rules for exchanging vacation properties or 1031 Exchanges in general, you should seek expert guidance to ensure the process goes smoothly. Speak to our advisors at 888-993-2835 or email us at info@firstname.lastname@example.org