Vacation homes have been a hot button issue for the IRS when it comes to 1031 exchanges. They have challenged the exchange of second homes, cabins, ski chalets, and the like. Their position is this: if the taxpayer uses the property primarily for personal use, it doesn’t matter that the taxpayer wanted it to appreciate in value and was hoping it was a good investment. What matters is the taxpayer’s use of the property. In short, you can’t exchange a cabin for another cabin if both properties are used for personal use.
Moore v. Commissioner
The seminal case in this area is Moore v. Commissioner. In 2008 the IRS went out of their way to create a safe harbor because a lot of taxpayers like to own vacation condos that are put into rental pools managed by companies that bring in periodic tenants. But the taxpayer may also want to use their condo for a few weeks a year.
So the IRS decided to look at the properties you sell in a 1031 and analyze the two years prior to sale to determine if it was used too much for personal property. They test each of those years to see if the taxpayer used it more than 14 days a year or more than 10% of the time it was rented. If you stay within the confines of this safe harbor, you can still do a 1031 exchange provided it was in a rental pool and your use didn’t exceed these thresholds.
Exchanging into a Vacation Home
The same analysis also applies if you’re exchanging into a property that is going to be put into a rental pool. On the replacement side, if you’re buying a condo you want to make sure that your personal use does not exceed 14 days a year, or 10% of the time it was rented.
Here’s a tip - don’t be cute with the IRS. If you’re going to go on vacation for a month and a half, rent a different condo than the one you own. Then you can avoid this common trap when it comes to 1031 exchanges of vacation homes.
- 1031 Hotline: If you have questions about 1031 exchanges of vacation homes, feel free to call me at 612-643-1031.
Defer the tax. Maximize your gain.
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