28 Mar IF YOU ARE LOOKING TO TAKE ADVANTAGE OF A 1031 TAX DEFERMENT ON THE SALE OF YOUR VACATION HOME, WATCH OUT FOR THESE PITFALLS:
MARCH 26, 2018 – Ever think about swapping out your investment property via a 1031 exchange to something that might make more money or simply be closer to home? Thankfully, if you do, Uncle Sam won’t hit you up right away for his portion of the money you made from the investment.
To qualify for the IRS’s 1031 exchange program, there are some important rules you must follow in order to defer your capital gains taxes when you buy a new investment property. The most important of these is that the property you will be buying must be of “like-kind” to the property you are selling and the property must be a true investment property and not for your personal use.
But what about vacation properties? More often than not, vacation properties are used both for personal enjoyment and also as income generating while you are not using it. That’s where things get tricky – for a 1031 exchange, you must rent the property for a portion of the year, a minimum of 14 days, at fair market value. You can also use the property, but just not too much. Whether you job gives you more than two weeks vacation or not, the IRS if of the mindset that two weeks is as long as you can stay in your vacation property in any given year.
As usual, the IRS is steadfast on these rules despite exceptions that might make you think your property is qualified to receive 1031 deferment.
Many people make incorrect judgments about how their properties qualify, but come to find out they have been rejected: For example, lets say you visit your vacation property a few weekends a year and stop by a few times to maintain it. Thankfully this investment has gone up in value, which might make you think it will qualify. If you never made an attempt to rent the property, never claimed deductions for maintenance or depreciation and deducted the interest as home mortgage interest, you’re out of luck.
Your vacation investment must be rented – at fair market value for that minimum of two weeks.
Did you spend two weeks in the property and then let your nephew and his friends use it for spring break? No dice – that will put you over the 14-day period that qualifies personal use. Did you trade time at your vacation home while you stayed in your neighbors ski villa? No luck there either – that’s still considered personal use because your neighbor did not pay fair market value to stay there.
Also, for the IRS to consider your property a true investment, they are going to expect you to value that investment as such and keep it properly maintained. This can be shown to the IRS by deducting expenses for maintenance, utilities, insurance and depreciation. If you visit the property to perform the work yourself, be prepared to show proof of work done – otherwise it’s “personal use.”
Lastly, how about that Villa in Tuscany? Yes, you can also exchange that, just keep in mind, it must be a property of “like-kind.” A condo on South Beach is not like your Tuscan Villa, so be prepared to exchange it for something outside the 50 states… (and yes, even Puerto Rico is outside those 50 states!)
If you have owned your investment for at least two years, and plan to own the new property for at least two years, then a 1031 exchange is something to look into. A 1031 exchange can be a nice perk for many investors who are looking to defer their tax payments, but it’s not a magic wand – eventually you’re going to need to pay that tax.