Exchanging Vacation Homes = Huge Savings

Planning and Patience Helps Preserve Wealth

After years of uncertainty as to whether or not a vacation home could be exchanged under Section 1031, the IRS provided highly anticipated guidance in early 2008. The problem though was that no one qualified!   

The guidance was in the form of a "safe harbor" provided in Revenue Procedure 2008-16 and creates the ability for vacation home owners of exchanging for another vacation home. To qualify for the protection of the "safe harbor," you would have to follow all of the rules which require you to rent the property for two years before you sell the old property and two years after you buy the replacement property while keeping your personal use to almost nothing. Most vacation home owners, especially those with resort properties along the East Coast, want to use their property often and have no desire to rent their property not even for just fourteen days annually. 

The requirements of the Revenue Procedure are summarized below:

RELINQUISHED PROPERTY:

    • Taxpayer owns the relinquished property for at least 24 months before selling;
    • Taxpayer rents the relinquished property for at least 14 days for each of the two 12-month periods immediately preceding the sale;
    • Cannot rent to a related party unless it is a year rental and related party uses the property as his/her primary residence; and
    • Taxpayer cannot use the property for personal use more than 14 days or 10% the number of days the property was rented, whichever is greater.

REPLACEMENT PROPERTY:

    • Taxpayer must rent the replacement property for at least 14 days for the two 12-month periods immediately following the acquisition;
    • Cannot rent to a related party unless it is a year rental and related party uses the property as his/her primary residence;
    • Taxpayer cannot use the property for personal use more than 14 days or 10% the number of days the property was rented, whichever is greater; and
    • If taxpayer is unable to satisfy the requirements on the replacement property, he/she must amend his/her return and report the sale of the relinquished property as a taxable sale and not a 1031 exchange.

While the Revenue Procedure didn’t work for anyone in 2008, it provided planning opportunities for those who own vacation homes and want to exchange it for a more desirable property without capital gains. A second home owner can establish a long-term plan to sell a vacation home, minimize personal use of the property to no more than 14 days per year and rent the property for a minimum of 14 days per year for the two 12 month periods preceding the anticipated sale. He can still enjoy the week of Fourth of July and the other two long Holiday weekends and qualify. 

Over the past few years, 1031 CORP. has facilitated a number of successful exchanges of vacation homes. In all situations, the property owner implemented a plan to qualify and exchange. They worked with their real estate professionals to secure the tenants and their planning and patience paid off. While the Revenue Procedure does prevent the owner from enjoying the properties year round for four full years, it did enable their owners to defer hundreds of thousands of dollars in capital gains, use pre-tax dollars to acquire another vacation home and preserve their wealth.