5-28-08

A 1031 or like-kind exchange is used to move appreciation from one piece of real estate to another tax free.  Following a defined set of rules under Section 1031 of the Internal Revenue Code of 1986, as amended (the "Code") , individuals and organizations can sell a real estate asset used for investment purposes and reinvest the proceeds into another real estate investment  on a tax-free basis.

Your primary residence, however, does not qualify for use as relinquished and/or replacement property for like-kind exchanges.  But what about vacation homes?

Many use their vacation homes as extensions of their primary residences. Others view their vacation homes primarily as assets, where personal use is limited and rental income is generated. For the latter group a 1031 exchange option is a possibility.  The IRS recently issued Revenue Procedure 2008-16 clarifying whether a "dwelling unit" such as a vacation home qualifies as "property held for the productive use in a trade or business or for investment purposes" and providing a safe harbor under which the IRS will not challenge whether the property qualifies as such. 

Dwelling units fall within the safe harbor under the Revenue Procedure if each of the following requirements are met with respect to both the relinquished and replacement properties: The taxpayer has owned the property for at least 24 months immediately before and after the exchange ("qualifying use period") and within the qualifying use period, in each of the two 12 month periods immediately preceding the exchange, the taxpayer rents the property to another person at a fair rental value for 14 days or more. Also, during this period, the taxpayer's personal use of the property does not exceed the greater of 14 days or 10% of the number of days during the 12 month period that the property is rented at fair value.  

In the event that a vacation home qualifies as property held for investment purposes, all of the other requirements of Code Section 1031 must be met in order to receive tax-free treatment on the exchange of properties.

If your use of any of your vacation homes was limited over the last 24 months and it was rented much more than occupied by you, then your second home may qualify as relinquished and/or replacement property for like-kind exchange purposes. To find out more, please contact Julia Turk at (312 840-7033 or jturk@burkelaw.com

Circular 230 Disclosure: Any tax advice contained in this article was not intended or written to be used, and cannot be used (i) by any taxpayer for the purpose of avoiding any penalties that may be imposed on the taxpayer, or (ii) to promote, market or recommend to another party any transaction or matter addressed herein.