IRS rule makes it easier to swap property
Limited personal use OK'd for homes in 1031 exchange
Question: Allison, What’s the latest scoop on the 1031 tax deferred exchange process? I hear there has been a change.
Answer: Good question! The Internal Revenue Service has handed investors and second-home owners a new gift in the form of a safety net that provides a "safe harbor" for taxpayers who wish to swap the property via a Section 1031 tax-free exchange even though they have enjoyed personal use of the property.
According to Tom Kelly with Inman News, Revenue Procedure 2008-16, which went into effect March 10, 2008, officially allows limited personal use of an investment property and will not prevent a dwelling unit from qualifying as property held for trade or business or investment use for purposes of the tax-free-exchange rules.
Many "second homes" are actually investment properties because their owners rent them out a majority of the year. The IRS has steered clear of any personal-use language regarding a tax-free exchange, but a new court case sparked a need for clarity "in the interest of sound tax administration."
The tax court held, however, that the properties were held for personal use and that the "mere hope or expectation that property may be sold at a gain cannot establish an investment intent if the taxpayer uses the property as a residence."
"While the IRS is fully aware that many people use their investment properties for their own vacations, the agency is now saying it will not challenge a 1031 exchange just because there was personal use of an investment property," according to Rob Keasal, real estate tax specialist in the accounting firm of Anderson ZurMuehlen. "It's the personal-use language that is new."
According to Section 1031 of the tax code, no gain or loss is recognized on the exchange of property held for productive use in a trade or business or for investment if the property is exchanged solely for property of like kind that is to be held either for productive use in a trade or business or for investment.
Personal residences can't be exchanged tax-free under Section 1031 because they aren't held for productive use in a trade or business or for investment.
In light of the
Strict personal-use rules of the investment property as a "second home" still apply. The period of the taxpayer's personal use of the dwelling unit cannot exceed the greater of 14 days or 10 percent of the number of days during the 12-month period that the dwelling unit is rented at a fair market value.
"Although the taxpayers hoped that both properties would appreciate, the tax court found in
Don't be afraid to use your lake place or ski condo even though it's an investment property and you plan to exchange it for another investment property down the road. If you limit your personal use, you will be sailing into the IRS's new safe harbor. ©Inman News 2008
For answers to your real estate questions, call Allison at 970-468-6800 or 1-800-262-8442