Rules Differ For Tax-Free Exchanges On Vacation Homes
The Federation
of Exchange Accommodators is a national trade organization formed in
1989 to represent those who are directly involved in Section 1031
Exchanges. At the organization’s midyear conference attendees shared
common challenges they faced regarding their property...vacation
homes topped the list.
Section 1031 of
the IRS code allows a property held for business or investment to be
exchanged tax free for another “like kind” property of equal or
greater value if the exchange adheres to specific guidelines. Which
category one’s property falls under is usually determined by how
many personal days you use the property for vacation.
If your
vacation home is an investment property, the rule is that personal
days must not exceed 14 a year, or 10% of rental days, whichever is
greater. If you want to use the vacation home in a tax-deferred
exchange, it must be used as a rental at least for the entire
previous year and rented out at fair market value. Homeowners can
flip-flop the status of the vacation home each year.
When planning a
1031 exchange, make sure the home held investment status for at
least the previous year before attempting an exchange. Although
there are no absolute rules as to how long the property should be
held as an investment, accountants suggest that the property show up
as a rental on at least two consecutive tax returns.
The consecutive
part is vital. If the property reverts back to a second home in the
year before the exchange, it would not be eligible for a 1031 trade.
A popular tax
strategy is to convert the second home to a primary residence. Say a
couple retire and sell their longtime family home, pocketing
$500,000 tax free from its sale. The couple move to their vacation
home, making it their primary residence. Two years later, they can
sell the place, move to an apartment and pocket up to $500,000 tax
free again because it had become their primary residence.
Although
vacation homes can certainly help with your financial picture, make
sure you are clear on the status before you attempt to trade or
sell.
