21
June
2017

How does 1031 exchange work with vacation homes?

Posted:

You are thinking about doing an exchange under Section 1031 of the Internal Revenue Code. As you very well know, the law makes no exceptions when it comes to personal residences. You cannot swap your primary residence for another one. What you can do, on the other hand, is defer state and federal capital gains tax when selling your vacation home. Yes, a vacation home does qualify for a 1031 exchange California. After all, a vacation home is an investment, right? What you need to do is take advantage of this rule while you can. There is no way of knowing what changes the future will bring.

How does the IRS policy apply on vacation homes?

Everyone who has completed a 1031 tax-deferred exchange knows perfectly well that the transaction is for business use. So, how can a vacation home possibly qualify for a like-kind exchange? Obviously, there must be some kind of misunderstanding. It is not a question of misunderstanding here, but of use. As long as a vacation home is used for rental purposes, it is an investment property. In other words, a vacation home that is rented is not for personal use. The point is that you can use the 1031 for exchanging vacation homes.  

When a vacation home is being held for investment

It is needless to say that the IRS has clear guidelines when it comes to determining whether or not a vacation home qualifies for a section 1031 exchange.  This is how your second home should be used:

  • Rental only. An asset that is used only for rental purposes at a fair market value is eligible for a 1031 exchange.
  • Rental with restricted personal use. It all depends on how much you use the vacation home for investment purposes and for personal use. If you use the property to a limited extent, then you can qualify for a like-kind exchange. Yet, only the business use portion of the second home.
  • Half rental use and half personal use. If the second home is used 50% for rental purposes and 50% for personal purposes, there is no hope. Or is there? If you rent the property most of the year, you could have a chance.
  • For personal use only. If the vacation home is used for personal use, then you cannot complete a like-kind exchange.

How to do a 1031 exchange on a vacation home

What you need to do is list your vacation home for sale. Attention should be paid to the fact that you cannot sell the asset it has not been held for at least 24 months. You have found a buyer. Good for you! The next thing you have t do is find a like-kind property, meaning an asset that is similar in nature. It is not necessary to specify that you cannot swap the vacation home for a primary residence. You should have understood that by now. Make your Qualified Intermediary enter the sale agreement. The seller will give the property to you and you have a new vacation home.

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