Vacation homes and 1031 real estate exchanges

Recent guidance released by the Internal Revenue Service (IRS) certainly clears a lot of the mystery that has surrounded the viability of completing a 1031 exchange upon the sale of a vacation home. Revenue Procedure 2008-16 became effective in March, 2008 and provides a safe harbor for taxpayers looking to complete an exchange with a vacation home. The ramifications are now clearly defined as to when the IRS will not challenge whether a vacation home will qualify for "being held for investment purposes" as required under Section 1031 of the Internal Revenue Code. Basically Revenue Procedure 2008-16 clarifies the difference between a vacation home held for personal enjoyment versus investment-held purposes. This is not to say that the vacation home cannot be used at all by the taxpayer, as long as defined "personal enjoyment" time frames are not exceeded. In order for a vacation home to qualify for a real estate exchange under Section 1031 of the Internal Revenue Code. The property must have been held for at least 24 months prior to the exchange. This is called "qualifying use period." Within each 12 month period of the qualifying use period, the dwelling unit must have been rented to another person at fair market value for at least 14 days. Personal use of the dwelling unit by the taxpayer must not exceed the greater of; 14 days or 10% of the number of days during each 12 month period that the dwelling unit was rented to other persons at fair market rental value. So you can see under these new guidelines that a vacation home that is sometimes used by the taxpayer can still qualify for a 1031 exchange. A beach condo, lake home or even a ski cabin that is used for some long weekends by the taxpayer will qualify for a tax deferred exchange as long as the above guidelines are adhered to. As an example, a taxpayer that has a seasonal property that is rented at fair market rental rates for about 2/3 of the year (approximately 240 days) can personally use that property personally for up to 24 days. Keep in mind that rental period is calculated as the first 12 month period immediately preceding the exchange and is not calculated on a calendar year. The same must hold true for each 12 month period prior. The second 12 month period ends on the day before the first 12 month period begins, and begins 12 months prior to that date and so on. There are some qualifications that must be met on the replacement property if that too is to be used as a vacation home: It must be owned by the taxpayer for a minimum of 24 months immediately following the exchange. The "qualifying use period." Within that qualifying use period, the same rental and personal enjoyment rules apply for each qualifying 12 month period. The taxpayer must rent the dwelling unit to another person at fair market rent for at least 14 days. Personal use of the dwelling unit must not exceed the greater of 14 days or 10% of the number of days during any qualifying 12 month period that the unit is rented to another person at fair market value. This opens up a lot of options to the taxpayer to take advantage of an exchange on vacation held properties. You can see it is now an option to upgrade your vacation property through a 1031 exchange. As long as the guidelines set forth in Revenue Procedure 2008-16 are met, the IRS will not challenge whether a vacation home will qualify as property "being held for investment purposes" under Section 1031 of the Internal Revenue Code. Russell Gullo, CCIM, CEA, is a certified exchange advisor, president of R. J. Gullo & Co., Inc., West Seneca, N.Y.