Do Vacation and Second Homes Qualify for 1031 Treatment?

Vacation or second homes held primarily for personal use by the Exchanger do not qualify for tax-deferred exchange treatment under IRC §1031. In Moore v. Commissioner, T.C. Memo 2007-134, the Tax Court ruled that properties held for personal use with only a hope or expectation of gain did not establish investment intent for a vacation home used solely for the personal enjoyment of the taxpayer, family, and friends.

Revenue Procedure 2008-16 provides safe harbors under which the IRS will not challenge whether a dwelling unit qualifies as property held for use in a trade or business or for investment purposes. A dwelling unit is defined as "real property improved with a house, apartment, condominium, or similar improvement that provides basic living accommodations including sleeping space, bathroom and cooking facilities".

Safe Harbor for Relinquished Property

For a vacation or second home to qualify as Relinquished Property in a §1031 exchange, the safe harbor requires the Exchanger to have:

1. Owned it for twenty-four months immediately before the exchange

2. Within each of those two 12-month periods:

   1. Rented the unit at fair market rental for fourteen or more days

   2. Restricted personal use to the greater of fourteen days or ten percent of the number of days it was rented at fair market rental within that 12-month period

Safe Harbor for Replacement Property

For a vacation or second home to qualify as Replacement Property in a §1031 exchange, the safe harbor requires the Exchanger to:

1. Own the vacation home for twenty-four months immediately after the exchange

2. For each of those two 12-month periods:

   1. Rent the unit at fair market rental for fourteen or more days

   2. Restrict personal use to the greater of fourteen days or ten percent of the number of days it was rented at fair market rental within that 12-month period

"Personal use" includes use by the Exchanger's friends and family members who do not pay fair market value rent. However, it would not include use as a related party's primary residence if the related party pays rent at a fair market rate (Adams v. C.I.R., T.C. M. 2013-7.-7)