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Vacation Homes & Tax Deferred 1031 Exchanges

1031 Exchange for Vacation Homes

Do you have a vacation or second home that doesn’t get used very often anymore? Have you considered replacing that home with something new?

If you’ve thought about selling that vacation or second home, have you wished you could sell it without having to pay high capital gain taxes? 1031 exchanges are popular among real estate investors to defer their capital gains taxes when selling their property, but does your vacation or second home qualify?

1031 Vacation Home Rules

Since March 10, 2008, rules on exchanging vacation and second homes have become much clearer. The IRS created specific guidelines making it possible to efficiently complete a tax-deferred 1031 exchange of a vacation or second home for a replacement vacation or second home.

The guidelines, as seen in Revenue Procedure 2008-16, state a vacation or second home can qualify as the relinquished or replacement property in a 1031 exchange if:

  • The subject property has been owned and held by the investor for at least 24 months immediately preceding the 1031 Exchange ("qualifying use period"); and
  • The subject property was rented at fair market rental rates to other people for at least 14 days (or more) during each of the preceding two years; and
  • The investor limited his or her personal use and enjoyment of the property to not more than 14 days during each of the preceding two years or ten percent of the number of days that the subject property was actually rented out to other people during each of the preceding two years.
  • While these guidelines help us understand how a vacation or second home can be considered an investment property to qualify under 1031 exchange regulations, some circumstances do not fall within these guidelines. Nevertheless, your property may still be eligible property for a tax-deferred 1031 exchange. So don’t miss an opportunity because you don’t fall perfectly within the mold, discuss your specific circumstances with your legal and tax advisors to see if your vacation or second home can qualify as an eligible relinquished property in a tax-deferred 1031 exchange.

    More About 1031 Exchanges & Vacation Rentals

    Some property owners interested in completing a 1031 exchange of vacation or second homes may feel these guidelines restrict them from determining the use of the properties they own. The fact is that 1031 exchanges were established to make tax allowances for investors and business owners to do business more efficiently. But who says you shouldn’t be able to enjoy a property purchased as an investment? Before 2008 and the guidelines of Revenue Procedure 2008-16, it was hard to determine whether or not a property used as a vacation or second home could be exchanged at all.

    Here’s a little history for your reference. In 1981 Private Letter Ruling 198103117 was issued by the Internal Revenue Service, indicating that properties that were, at least partially, used for investment or business purposes could be exchanged. Then in 1991, the Department of the Treasury issued the Deferred Exchange Regulations that indicated only properties held solely for investment or business could be exchanged. It wasn’t until 2007 when Tax Court Memorandum 2007-134 was filed and clarified that as long as the primary intent for the property was investment or business, the property could also have personal uses. The hard part was determining how to prove primary intent. Since the guidelines of Revenue Procedure 2008-16 were published, we now know for how long and how a property must be used to establish its eligibility for a tax-deferred 1031 exchange without having to define the owner’s intent for the property.

    Depending on your circumstances, jumping through hoops to make your vacation or second home fall within these guidelines may or may not be worth it to you. But, at least you now know it’s possible to sell or acquire a vacation or second home through a tax-deferred exchange.

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    This material does not constitute an offer to sell or a solicitation of an offer to buy any security. An offer can only be made by a prospectus that contains more complete information on risks, management fees and other expenses. This literature must be accompanied by, and read in conjunction with, a prospectus or private placement memorandum to fully understand the implications and risks of the offering of securities to which it relates. As with all investing, investing in private placements are speculative in nature and involve a degree of risk, including loss of your principal. Past performance is not necessarily indicative of future results and forward-looking statements and projections are not guaranteed to achieve the results described and your actual returns may vary significantly. Investments in private placements are illiquid in nature and there may be no secondary market or ability to sell the investment should the need for liquidity arise. This material should not be construed as tax advice and you should consult with your tax advisor as individual tax situations will vary. Securities offered through Capulent, LLC, member FINRA, SIPC.