Taxpayers often own a vacation home or other residential property that they desire to exchange in a tax-deferred like kind exchange under Section 1031 of the Internal Revenue Code. Under Section 1031, no gain or loss is recognized on the exchange of property held for use in a trade or business or for investment if the property is exchanged solely for property of like kind that is to be used in either a trade or business or for investment. Personal residences and similar personal-use property generally do not qualify as property held for investment or used in a trade or business within the meaning of Section 1031. When it comes to vacation homes and similar property that a taxpayer uses occasionally for personal use, there has generally been uncertainty as to whether or not that property would qualify for a Section 1031 exchange.
The IRS has issued Revenue Procedure 2008-16 which provides a new safe harbor for applying Section 1031 in these situations. Under this Revenue Procedure, the IRS will not challenge whether or not a dwelling unit qualifies under Section 1031 as property held for productive use in a trade or business or for investment if it meets the following requirements:
1. The taxpayer must own each of the properties (the two properties exchanged) for the “qualifying use period,” a term defined in the Revenue Procedure as either the 24 month period before the exchange (for the relinquished property) or the 24 month period after the exchange (for the replacement property). Therefore, for the relinquished property, the taxpayer must have owned the property for at least 24 months immediately before the exchange and for the replacement property, the taxpayer must continue owning it for at least 24 months immediately after the exchange.
2. Within the qualifying use period, in each of the two 12 month periods immediately preceding the exchange (for the relinquished property) and in each of the two 12 month periods immediately following the exchange (for the replacement property), the taxpayer must rent the dwelling unit to another person at a fair rental for 14 days or more and the period of the taxpayer’s personal use of the dwelling unit cannot exceed the greater of 14 days or ten percent of the days during the 12 month period that the dwelling unit is rented at a fair rental.
The Revenue Procedure is effective for exchanges occurring after March 9, 2008.