If you’re considering using a vacation home or second residence in a 1031 Exchange, clarity around IRS rules is essential. Although these properties are often purchased for personal use, under certain conditions they can qualify as investment property. The following explains the safe harbor criteria, timelines, and IRS requirements you must follow to preserve tax‑deferred status.
Vacation Homes Held for Personal Use Do Not Qualify
It has been established that vacation or second homes held by the Exchanger primarily for personal use do not qualify for tax deferred exchange treatment under IRC §1031. In Moore v. Commissioner, T.C. Memo 2007-134, the Tax Court held that properties held for personal use with the mere hope or expectation of gain did not establish investment intent for a vacation home used only for the personal enjoyment of the taxpayer and his family and friends.
IRS Safe Harbor Under Revenue Procedure 2008‑16
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.”
Conditions for Qualifying a Vacation or Second Home
Ownership Duration & Rental Requirements
The safe harbor for a vacation or second home to qualify as Relinquished Property in a § 1031 Exchange requires the Exchanger to have owned it for twenty-four months immediately before the exchange, and within each of those two 12-month periods the Exchanger must have 1) rented the unit at fair market rental for fourteen or more days, and 2) restricted personal use to the greater of fourteen days or ten percent of the number of days that it was rented at fair market rental within that 12-month period.
The safe harbor for a vacation or second home to qualify as Replacement Property in a § 1031 Exchange requires the Exchanger to own the vacation home for twenty-four months immediately after the exchange, and for each of those two 12-month periods the Exchanger must 1) rent the unit at fair market rental for fourteen or more days, and 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 Definition
“Personal use” includes use by the Exchanger’s friends and family members that do not pay fair market value rent, but 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.
CLICK TO DOWNLOAD VACATION & SECOND HOMES REV PROC 2008-16 REFERENCE PDF
For more information read:
Revenue Procedure 2008-16
Strategic 1031 Homebuying
How to Buy Your Vacation Home with a 1031 Exchange
