The allure of a tiny home or tiny office appeals to a growing number of people and we are seeing many creative uses. Besides being used as a primary residence, tiny homes are now being utilized as a backyard sanctuary, office or school workspace ‘in a box’, business outlet separate from a residence, short or long term rental – the enticing list goes on. And the investment opportunity appears to be equally alluring. In research we recently posted, we found 72% would consider buying a tiny home to serve as an investment property. For investors, the tax planning strategic question is whether the tiny home or tiny office qualifies for tax deferred 1031 treatment?
The simple answer is yes – with proper planning.
Section 1031 of the Internal Revenue Code allows you to sell your investment real estate and purchase other investment or business use real estate and defer taxes on the gain.
For investors selling investment real estate and looking to purchase tiny houses as their 1031 Exchange Replacement Properties, there are a few things to consider:
- LAND. As 1031 Replacement Property, a tiny home/office cannot be put on land or property that you already own (i.e. in your backyard). However, you could purchase new Replacement Property such as a rental home, vacant land or even multi-unit property, conducting a Reverse Build-to-Suit Exchange to add one tiny home/office (or many).
- PORTABILITY. Moveable properties are not considered real estate, so they cannot be exchanged. If the tiny home/office has wheels or is built on a flatbed vehicle, you’re out of luck. For 1031 treatment, a tiny home/office needs to be a permanent structure. And be sure to check with your county for clear definition on a “small house”, any zoning requirements or other restrictions.
- USAGE. If your intention is to use a tiny home/office strictly for personal use, it will not qualify for 1031 tax deferral. However, if intent is for investment purposes, read Revenue Procedure 2008-16 which provides safe harbor rules for dwelling units.
For investors or prospective investors interested in tiny home/office investment, with proper advance planning, a future 1031 Exchange may be possible.
- If your intention is to rent the tiny home/office (i.e. Airbnb/VRBO or longer term rental/lease), this positions you well for a future 1031. A tiny home/office may become a ”dual use” property and qualify for gain exclusion under Section 121 (the primary residence exemption) and the tiny home/office as business or investment real estate being eligible for tax deferral under Section 1031. This could be a dual win with immediate rental income and increased property value.
- You may be able to declare a tiny home/office as a home office for tax purposes. Again, when you sell your property, a portion of the property can be used for tax deferred 1031 Exchange.
There are many opportunities to take advantage of tax deferral by using a 1031 Exchange for tiny homes or offices – immediately or in the future. And for millennials or first time investors, a tiny home may be a great first step to dally in real estate investment, opening up the potential power of 1031 tax deferral.
As with any 1031 Exchange, it’s important that you talk to your tax and legal advisors on how to best structure. Then reach out to the experts at IPX1031 to facilitate your 1031 investment opportunity.
Opportunities of the 1031 Exchange
Survey Reveals America’s Ideal Tiny Home and Tiny Office
Do Vacation and Second Homes Qualify?
How to Buy Your Vacation Home with a 1031 Exchange
How to Maximize 1031 Via Your Home Office
2 Is Better Than 1: A 1031 Win with Dual Use Property