A 1031 exchange allows you to sell one property and use the cash to acquire another without paying capital gains taxes right away. You may defer your gain as many times as you like. There are numerous procedures and deadlines that must be followed to complete the transaction lawfully. However, when it comes to vacation homes, the procedure is more challenging.
Understanding The Rules for Vacation Properties
If you are considering using a 1031 Exchange for a vacation property, you must ensure that you are in compliance with the following rules put forth by the IRS:
- You've engaged in a "like-kind" exchange.
- The property helps you earn income and therefore can demonstrate "productive use."
- You must have owned the relinquished property at least 24 months prior to the exchange.
- You have rented the property at fair market value for 14 or more days per year within each of the two 12-month periods prior to or after the exchange.
- Personal use of the property was limited to 14 days or 10% of the number of days rented at fair market value-- whichever is greater.
You'll also want to keep detailed records to prove each point above. It can be helpful to keep a ledger showing your income, expenses, and how the property was used over the course of ownership in the event you are asked for an accounting of your time spent at the property by the government.
If you don't follow these rules, the IRS may reclassify your vacation home as a "non-qualified" property. This would mean that you would have to pay capital gains taxes on the sale.
It's possible to use a 1031 Exchange to buy a vacation home, but it's important to be aware of the rules and restrictions. Work with a qualified intermediary to ensure that you are in compliance with the IRS requirements. This will help you avoid any issues down the road. If you have questions or would like to speak to one of our qualified intermediaries, contact us at 888-508-1901 to schedule a consultation.