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Do Vacation Homes Qualify for Tax Deferral Under Section 1031?

It Is Possible To Have Successful Second/Vacation Home Exchanges

Property owners throughout the nation are obtaining the benefit of full reinvestment of equity under Internal Revenue Code §1031. Many investors exchange a single-family rental, duplex, or any other type of investment property for an investment property held for investment in a resort or vacation area. Many tax/legal advisors believe it is possible to perform an exchange on a vacation property that is held for investment purposes.

Support For Vacation Home Exchanges?

In Private Letter Ruling (PLR) 8103117, the IRS did allow for tax deferral when a property owner intended to acquire property for personal enjoyment and as an investment. As stated in this PLR, “…the house and lot you acquire in this trade will be held for the same purposes as the properties exchanged: to provide for personal enjoyment and to make a sound real estate investment.”

Although a PLR only applies to the facts and circumstances in a particular individual’s specific situation, it appears, in this instance, that the “personal enjoyment” of a property does not prevent a property owner from benefiting from a tax-deferred exchange.

Each Individual Case Must Be Reviewed

Note: There are no regulations, statutes, or court cases that give a definitive answer on vacation home exchanges. Each vacation home exchange must be reviewed on a case-by-case basis. To qualify for a 1031 exchange, the property owner should be able to support that the property was “held for investment.”

A Brief Analysis

IRC Section 1031 provides for the non-recognition of gain on the exchange of property “held for productive use in a trade or business or for investment.” Is a vacation property considered “held for investment”?

Reg. 1.1031(a)-1(b) states in the definition of “like-kind” that “productive real estate held by one other than a dealer for future use of future realization of the increment in value is held for investment and not primarily for sale.” It appears that even property owners who have never rented their vacation property but can substantiate that they acquired and held the property because they expected it to increase in value (a wise investment decision) may qualify for a 1031 tax-deferred exchange. IRC § 165 and §280, which address when losses may be deducted on vacation homes, may provide additional guidance to investors.

It is well known that many vacation areas have appreciated significantly and that often property owners purchase properties with future appreciation in mind. Real estate investors should consult with their own advisors to discuss their specific situation and see if they may qualify for the benefits of a tax-deferred exchange.