1031 Exchanges for Vacation Homes
If you own a vacation home that is used as a rental as well as for your personal enjoyment, can you upgrade to another property without paying capital gains taxes? Yes, so long as you follow strict criteria to qualify for a 1031 vacation home exchange. In this guide, we draw on our expertise with 1031 vacation home exchanges to ensure the eligibility and compliance of your exchange.
Benefits of Using 1031 Exchange for Vacation Homes
One benefit of using a 1031 exchange for vacation homes is that it lets you diversify your real estate investment portfolio. Another is that you can upgrade to a more desirable property, without paying capital gains taxes.
It can even let you use funds from the sale of your relinquished vacation home to make improvements to the new vacation home. But this type of exchange has very specific requirements that must be met, in order for it to be successful.
Eligibility Criteria for Vacation Homes
What Are the Rules for a 1031 Vacation Home Exchange?
In short, during the first two 12-month periods after the exchange, you must rent the property for more than 14 days throughout the year, and use it for personal use fewer than 14 days per year, and no more than 10% of the nights rented. If you meet these criteria, then you can invest the proceeds from a relinquished property into a like-kind replacement property.
Intent of the Investor
The primary intent of the investor to use the replacement property for investment purposes, at the time of the exchange, is the key factor in determining whether it is held for personal use or as an investment. Call us at 916-252-6900 for help determining and articulating your primary intent for the property.
Only Dwelling Units Are Eligible
The IRS defines a dwelling unit as a piece of real property with a house, apartment, condominium, or other structure that furnishes basic living accommodations, including a sleeping area, bathroom, and cooking capabilities.
What Does and Does Not Count as Personal Use?
If you, your family members, or anyone else who has an ownership interest uses the property without paying fair market rent, that counts as personal use. If anyone pays fair market rental rates, it is not considered personal use, even if the property is their primary residence.
Fair market rental rates are determined based on the circumstances that exist when the rental or lease agreement is signed.
If You Are Working on the Vacation Home, Does It Count as a Personal Use Day?
If you are a DIY lover or fixer-upper with plans to make improvements to your vacation home, then any days you spend working on the property do not count toward the 14 day limit. In other words, you can stay at your new vacation home as much as you like, so long as you are doing work to improve its value.
What Happens After Two Years?
After two 12-month periods of restricting your use of the vacation home to 14 days, and renting it out to guests for 10 times as often as you stay there, you will have fulfilled the requirements and be free to stay there as much as you like. Note, however, that if you continue to rent it out to paying guests for at least 14 days each year, you may be eligible to write off rental expenses and so reduce taxes.
Potential Exceptions to the Rules
Your 1031 vacation home exchange may still qualify for deferral of capital gains taxes, even if you do not follow the guidelines. Call us at 916-252-6900 for a free consultation, to determine the specifics of your exchange, and help set a winning strategy.
Steps to Complete a Vacation Home 1031 Exchange
1
Contact 1031 Pros for advice on structuring your 1031 vacation home exchange.
2
Because Section 1031 does not allow you to own both properties at the same time, you will sell the relinquished property through a qualified intermediary and Exchange Accommodation Titleholder (or EAT), or in some cases acquire the replacement property first through a parking agreement.
3
As your qualified intermediary, we will set up a special purpose entity, often a single member limited liability company, that is used to acquire and park the title to your replacement property during the exchange.
4
We will work with you to ensure compliance with all IRS regulations, and successful completion of your exchange.
5
At the end of the exchange, the replacement property and any construction loans will often be transferred to you through the holding entity, rather than by a deed.
What Should I Look for in a Qualified Intermediary?
When selecting a qualified intermediary, be sure to choose one with experience in 1031 vacation home exchanges, as the rules and regulations for these are quite different from other 1031 exchanges. They should also have expertise in navigating the unique challenges of vacation home markets, and help you understand how 1031 exchanges can benefit your portfolio and your life.
At 1031 Pros, we do all of this and more, including offering personalized consultations to align your vacation home investments with broader financial plans, access to real estate management services, and more. We also bring top tier customer service to the table – always answering your phone calls, at any time day or night, and replying to emails within 24 hours.
Financial Considerations and Planning
We are committed to helping you plan wisely for your exchange, so you make the most of your investment. Vacation home 1031 exchanges have very specific criteria and can be more time consuming than other exchanges. For example, if you are making improvements to your replacement property, be sure that your financing is secured before starting the exchange. Also, be sure that your budget includes room for expenses such as transaction and legal fees. As 1031 vacation home exchange experts, we are here to help guide you through the entire process.
Selecting the Right Vacation Home
Of course, your new vacation home should be a place that brings you delight and joy. But there are other factors to take into consideration. Before entering any real estate transaction, closely examine the economic stability of the area where your replacement property is located.
Ideally, you will find a property in a strong market, as well as one that allows significant value-add through improvements, or even one that is under market value with high upside potential. It’s important to understand market trends and future growth potential, and we’ll work with you to help make sure that you select the right replacement property.
Legal and Tax Expertise
1031 vacation home exchanges must conform to IRS guidelines and laws at the state and local level, and must also be compliant with the rules specific to 1031 exchanges. At 1031 Pros, we are expert professionals who specialize in real estate and tax considerations, so we can help you mitigate risk and maximize the reward you get from your vacation home.
Real Customers, Real Stories
“Honestly, you have been great!! I will forever recommend you to all my clients. Thank you for your prompt responses and being on top of everything. Thank you all for working so hard to get this done. I just wanted to tell you all I appreciate it.”
– Ana Torres
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