An alternative to selling your vacation home may be a like-kind exchange. In a like-kind exchange, also known as “1031 exchanges,” no gain or loss is recognized on the exchange of like-kind property. Housing brings some special issues to like-kind exchanges.
Traditionally, the IRS has held that gain or loss from an exchange of personal residences may not be deferred under Code Sec. 1031. As the IRS saw it, residences are not typically property held for productive use in a trade or business or for investment. A few years ago, the IRS announced an important change. The IRS will not challenge a vacation home as qualifying for a like-kind exchange as property held for productive use in a trade or business or for investment if the home is only occasionally used by the taxpayer for personal use and is predominately used to generate rental income.
In a like-kind exchange, there is relinquished property and replacement property. The two must be of like-kind.
Under the IRS guidance, your vacation home will qualify as property held for productive use in a trade or business or for investment if you own it for at least 24 months immediately before the exchange. Within that qualifying use period, in each of the two 12-month periods immediately preceding the exchange, you must rent the home to another person for 14 days or more at fair rental value. Additionally, your personal use of the home must not exceed the greater of 14 days or 10 percent of the number of days during the 12-month period that the dwelling unit is rented at a fair rental.
After you have exchanged your home, the IRS guidance requires you to follow similar rules for the replacement property. A replacement property qualifies as property held for productive use in a trade or business or for investment if the home is owned by the taxpayer for at least 24 months immediately after the exchange. Within that qualifying use period, in each of the two 12-month periods immediately after the exchange you must rent the home to another person for 14 days or more at fair rental value. Additionally, your personal use of the home must not exceed the greater of 14 days or 10 percent of the number of days during the 12-month period that the home is rented at a fair rental.
The IRS is warning that it will not tolerate abuses. You must rent the home to another person at fair rental value. Your personal time cannot exceed the limits set by the IRS. The IRS also has very strict requirements about personal use.
If you have any questions about these requirements, please don’t hesitate to contact our team.
