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Newsletter - Spring 2008
Vacation Homes & 1031 Exchange Privilege
Dave Roberts, Paincipal, Tax & Business Services |
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For many years taxpayers have been unable to take advantage of the Section 1031 exchange treatment on the capital gain from the sale of a second home that is treated as a vacation home (or mixed-use property). In general, taxpayers can only swap property that has been held for business or investment purposes for other like-kind property that will also be held for business or investment purposes if they want to obtain Section 1031 exchange treatment.
Recently, the IRS announced a new revenue ruling that allows taxpayers Section 1031 like-kind exchanges of their mixed-use properties. This new procedure provides a safe harbor under which the IRS will not challenge whether a dwelling unit qualifies as property held for productive use in a trade or business or for investment for purposes. To be eligible, a property must be a dwelling unit, meaning it is improved with a house, apartment, condominium or similar improvement that provides basic living accommodations including sleeping space, a bathroom and cooking facilities. The safe harbor is effective for exchanges of dwelling units that occur on or after March 10, 2008.
In addition, certain guidelines must be followed regarding the ownership and rental periods for both the replacement and the relinquished properties involved in the exchange:
RELINQUISHED PROPERTY - Property owned at the time of the exchange:
- Must be owned for at least 24 months
- Must be rented to another person(s) at a fair market rental for 14 days or more a year
- The taxpayers' personal use of the property should not exceed the greater of 14 days a year or 10% of the number of days during the 12-month period the dwelling unit is rented at a fair market rent.
REPLACEMENT PROPERTY - Property acquired after the Section 1031 exchange:
- Must be owned for at least 24 months
- Must be rented to another person(s) at a fair market rental for 14 days or more a year
- The taxpayers' personal use of the property should not exceed the greater of 14 days a year or 10% of the number of days during the 12-month period the dwelling unit is rented at a fair market rent.
The new safe harbor certainly provides some comfort which should allow taxpayers to swap properties and defer any gain recognitiontowards the future.
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