New IRS Ruling for 1031 Exchanges and Vacation Homes

The Internal Revenue Service has recently issued a new ruling laying out some guidelines for individuals wanting to use a 1031 Exchange for their vacation homes. The ruling was released as a Revenue Procedure (2008-16), meaning it describes what steps the taxpayer must take in order for the IRS not to contest the investment standing of their vacation homes.

This issue came to the forefront last year when the U.S. Tax Court ruled against a taxpayer's exchange from one vacation home to another. Since you can only exchange property that is held for investment (or used in a trade or business), the court's ruling gave rise to the question of whether a vacation home is an investment or personal use property. The new guidelines are an attempt by the IRS to try and answer that question.

Under the new ruling, a vacation home must meet the following guidelines in order to qualify for a 1031 Exchange:

• The vacation home must be held for 24 months.
• The 24 month holding period applies to the old property (if it is your vacation home), the new property (if you are buying it as a vacation home) and two both propertiesif you are moving from one vacation home to another.
•  For every 12 month block of the 24 month holding period, you must rent the property for a minimum of 14 days at the prevailing fair market rent.
• For every 12 month block of the 24 month holding period, the owner is only allowed to use the property for the "greater" of 14 days or 10 percent of the total days rented.
• Owners are allowed a reasonable number of "maintenance days" to care for their units.

So, what does this ruling mean for vacation home owners? The answer is multifaceted. First, because it is a safe harbor ruling, failing to comply with all the guidelines does not mean the exchange will be automatically denied or that an audit will occur. It does mean however that owners will have to keep good records of both of the property's rental history and the dates the property was occupied for maintenance. Second, days that you allow relatives or friends to use the unit without paying rent will count against your personal use days. And finally, for owners who have never rented their units and/or used them personally for extended periods of time, the new ruling will likely wipe out your chances for doing a 1031 Exchange.

The experts who have reviewed the new guidelines all tend to agree that vacation home owners considering doing a 1031 Exchange at some future date need to be serious in their attempts to rent out their properties, charge fair market rent to everyone who uses it and keep meticulous records of everything that occurs with the occupancy of the property. Your success in doing a 1031 Exchange may depend on how well you do them all.

Gulf Coast Associates, Realtors® specializes in upscale Southwest Florida properties from Bonita Springs to St. Petersburg.

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