Until several recent rulings, it has been difficult to determine what the IRS expects when it comes to Vacation homes and how they are treated in the context of the 1031 exchange. Thanks to Revenue Procedure 2008-16 and Moore v. Commissioner, we now have clear guidelines as what would qualify and what would not. In order for your vacation home to qualify for 1031 treatment, the following criteria must be met:
During the 24 months prior to the sale of your vacation home:
You must show that you have rented the property at fair market value for at least 14 days each year.
You must not use the property personally for more than the greater of 14 days or 10% of the number of days the property was rented each year.
These same criteria hold true for the replacement property that you purchase should it also be a vacation home.
Here is an example:
John and Mary Smith own a Condo on Fort Myers Beach that they are getting ready to sell, and would like to do a 1031 exchange. Here are the details on the property:
Owned Condo for 7 years
Condo has been in a Rental Program and rented 200 days each year
Personal use is 17 days each year
Based on the criteria outlined, they cannot use the property more than 10% of the number of days that the property was rented each year, or 20 days. Since they only used it for 17 days each year, they meet the criteria.
In addition to making sure that your personal use falls within the established guidelines, there some other steps you can take to support that your vacation property is a viable exchange property. First, deduct any mortgage interest and property taxes on Schedule E as a business expense, as well as any repair costs, depreciation and miscellaneous expenses. Next, make sure that it is clear from the beginning that your intention with this property is to treat it as an investment. Finally, keep a log of what days you use it personally, what days you were doing work on the property, etc. These are all easy steps to take to further ensure that your exchange is solid should you ever find yourself as the subject of an IRS audit.
Theresa Knower, CISP, CES
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