Exchanging vacation homes and other potentially personal use property has long been a controversial topic in the Exchange business. Section 1031 excludes personal use property from the definition of 1031 exchanges. Vacation homes include: properties exclusively rented out to other parties and not used personally; and properties rented partially during the year with some personal use. The status of properties that are neither used by the client nor rented out must be analyzed under prior law.
One common advantageous planning opportunity before 2009 was to sell investment or business property in a 1031 exchange, then acquire a vacation property, rent it for a period of time to qualify for investment use and then later, upon retirement by the client, convert the vacation property to personal use as a residence. Between 2004 and 2008, individuals who converted such property to a personal residence and who lived in the property for at least 2 years, were eligible to exclude up to a maximum of $500,000 of gains upon sale. This created a tremendous incentive for investors to reposition their assets to vacation properties. The Housing and Economic Recovery Act of 2008 changed the rules for sales of personal residences after 12/15/08. Gain attributable to the period of time prior to the personal home residence ownership period for vacation homes could no longer be excluded.
Prior to the issuance of the Tax Court decision in Moore v. Commissioner May 2007, there was very little if any guidance from the IRS whether vacation property could qualify for a 1031 exchange. In Moore v. Commissioner, T.C. Memo. 2007-134 , the taxpayers exchanged one lakeside vacation home for another. Neither home was ever rented. Both were used by the taxpayers only for personal purposes. The taxpayers claimed that the exchange of the homes was a like-kind exchange under Section 1031 because the properties were expected to appreciate in value and thus were held for investment. The Tax Court held, however, that the properties were held for personal use and that the “mere hope or expectation that property may be sold at a gain cannot establish an investment intent if the taxpayer uses the property as a residence.”
In order to provide guidance in this area, the IRS issued Revenue Procedure 2008-16 on March 10, 2008 which provided guidelines as to whether an exchange of a dwelling unit (residence) would qualify for a 1031 exchange.
The residence owned by the investor must, for the preceding 24 months prior to the sale and for the 24 months after the exchange, be rented to another unrelated person for fair rental for 14 days or more per annum and the investor’s personal use does not exceed the greater of 14 days or 10 percent of the number of days rented at a fair rental. If the investor meets the above requirements, the property can be exchanged pursuant to Section 1031.
Call our office at (513) 412-3481 or toll free at (800) 427-7212. Our exchange coordinators are ready to discuss whether this type of exchange is right for you and how to get started.