Can you do a 1031 Exchange on a second home? That was the question a client asked me earlier this week. The answer? It depends..
One of the questions often asked is whether you can 1031 Exchange out of a vacation property or second home and into other investment property, vacation property or second home.
IRS Section 1031 may be available for vacation property owners seeking to defer capital gain taxes on the sale of a vacation-type property. The main issue, in most cases, is whether the properties sought to be exchanged are held “for the productive use in a trade or business or for investment,” or whether they are held exclusively for the personal use of the taxpayer.
Revenue Procedure 2008-16 creates a “safe harbor” for exchanges of vacation property or second homes. This means that if the specified ownership and use requirements are met, the property will qualify under Section 1031.
The sale of a vacation property or second home will qualify 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 (2) 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 (2) years, or ten percent (10%) of the number of days that the subject property was actually rented out to other people during each of the preceding two (2) years.
The purchase of a vacation property or a second home will qualify if:
– The subject property is owned and held by the investor for at least 24 months immediately following 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 following two (2) years; and
– The investor limits his or her personal use and enjoyment of the property to not more than 14 days during each of the following two (2) years, or ten percent (10%) of the number of days that the subject property was actually rented out to other people during each of the following two (2) years.
What about my second home that is not rented?
A second home is just that; a second home. A second home or a vacation home held strictly for personal use with no rental activity at all is considered a second home, and does not qualify for the tax deferral benefits of a Section 1031 exchange. The mortgage interest and real estate taxes are tax deductions on Form 1040 Schedule A of the federal tax return. No other expenses, including repairs, maintenance or insurance, are deductible.
Tax Consequences at Disposition: The property owner may be able to take advantage of the exclusion from capital gain provided by IRC Section 121 if they can establish this home has been their primary residence for twenty four (24) of the past sixty (60) months. Section 1031 non-recognition treatment is not available because the property has been held solely for personal use.
What are the consequences for my home that is rented more than 15 days a year but I use it frequently?
Tax Consequences during Ownership: If a vacation home is rented more than 15 days during the year, the rental income must be included as rental income and added to gross income. The expenses associated with renting the vacation home can be deducted. The expenses associated with the vacation home must be allocated between personal and rental use and the amount of rental expenses that may be deducted will depend on the number of days the home was rented.
Tax Consequences at Disposition: This type of property may potentially qualify for a Section 1031 exchange, provided that the taxpayer and their tax advisors can establish that the ‘primary purpose’ of holding the property was for investment purposes. If the property owner has substantially more than two weeks of personal use per year, however, this may be difficult to establish.
More information: Tax and 1031 Aspects of Orange County of Vacation and Second Homes
About Jaleesa Peluso, Orange County Real Estate Agent
Jaleesa and her real estate team specialize in South Orange County homes and neighborhoods, including: Dana Point, Irvine, Laguna Beach, Laguna Niguel, Newport Beach and San Clemente. Thinking of making a move in to Orange County? Call us now at (949)395-0960!
This information is provided solely as a courtesy by Jaleesa Peluso, Laguna Beach Realtor. It is deemed reliable, but not guaranteed. Rules and Regulations may change without notice.