Table of Content
- Is it possible to do an exchange using the proceeds from the sale to improve a property that I already own?
- The rules of a 1031 exchange with multiple properties
- IRS Guidelines for 1031 Exchange on Vacation Rental or Second Home
- What restraints do I face when identifying my replacement property(ies)?
- Does a Vacation Home Qualify for 1031 Exchange?
Say you complete a 1031 Exchange; rent out the property for two years; occupy it for three; and then rent it for another year before selling. You’re allowed four years of ownership toward the primary residence exclusion. Two-fifth of the $90,000 ($36,000) is subject to capital gain taxes for the two years of non-qualified 121 use as a rental.
IRC Section 1031 has many moving parts that real estate investors must understand before attempting its use. An exchange can only be made with like-kind properties, and Internal Revenue Service rules limit its use with vacation properties. There are also tax implications and time frames that may be problematic. Swapping your income property for a vacation rental home as part of a 1031 exchange is a personally rewarding way to level up your investment.
Is it possible to do an exchange using the proceeds from the sale to improve a property that I already own?
No surprise, the transaction failed to receive Section 1031 treatment. The Court found no intent to hold property for productive business use or investment purposes. Also, there’s ways to a successful exchange without safe harbor guidance.
There are also ways that you can use 1031 for swapping vacation homes—more on that later—but this loophole is much narrower than it used to be. However, if the taxpayer wants to acquire another vacation home, they can do a Section 1031 Exchange. If the taxpayer finds another home worth $1,100,000, they would swap their old vacation home for the new one and throw in $100,000 cash to equalize the trade. As long as they have met the abovementioned guidelines for both properties, a tax-deferred Section 1031 Exchange is ok, and the taxpayer avoids any current income tax hit.
The rules of a 1031 exchange with multiple properties
Relinquishing multiple properties and replacing them with a single property. With rapid acceleration in condensed areas, a second home can bring a tremendous gain in the right areas of the country. Conversely, natural disasters, poor upkeep, or depleting local economies unfortunately often land vacation property sellers with less than what they paid for originally. With over 20+ years of experience in real estate investment and renovation, Brian Robbins brings extensive knowledge and innovative solutions to the HouseCashin team.
A 1031 exchange is considered a “like kind” exchange of property. This exchange can be tricky and should be conducted through the services of a Qualified Intermediary, also referred to as an Exchange Accommodator. You get to exchange like properties for like, the term “like” is very broad in this context. You could exchange commercial space for residential or even undeveloped land.
IRS Guidelines for 1031 Exchange on Vacation Rental or Second Home
The IRS also has very specific requirements regarding personal-use if the property is used by the owner for any part of a day. This includes the owner who has an interest in the second home or vacation property as a tenant-in-common interest. Another IRS requirement specifies that if the owner rents out the vacation or second home property at less than fair market value, the days rented are considered personal use days. Vacation homes are one of the most common and useable assets in 1031 exchanges. Many wealthy investors use the opportunity to “trade up” for new property tax-free. In this article, we will outline the steps necessary to 1031 exchange second home or other vacation property and avoid capital gains tax and maximize profit.
The 121 exclusion applies to 3/5ths but not the 2/5ths of the gain when rented out. The exclusion also does not apply to the depreciation recapture. The practice of deferring capital gains tax through like-kind exchanges is increasing in popularity.
Moving Into a 1031 Swap Residence
One of the main ways that people get into trouble with these transactions is failing to consider loans. You must consider mortgage loans or other debt on the property that you relinquish, as well as any debt on the replacement property. If you don’t receive cash back but your liability goes down, then that also will be treated as income to you, just like cash. The second timing rule in a delayed exchange relates to closing.
Get the edge you deserve when it comes to understanding the power of wealth building tax-deferral and tax-exclusion strategies. Sera Capital is a Registered Investment Advisor and real estate consultant that manages money for individuals, families and other advisors. IPX1031 is a full service Qualified Intermediary with highly specialized exchange divisions to handle any type of exchange transaction nationwide. The offers that appear in this table are from partnerships from which Investopedia receives compensation. Investopedia does not include all offers available in the marketplace.
Personal property, unlike real property, is more restricted in a 1031 Exchange. The IRS is less inclined to state that one type of personal property qualifies as like-kind for other personal property. For example, personal property may be characterized as depreciable tangible property, intangible property and non-depreciable personal property. Personal property within each category is not necessarily like-kind. Any personal property held as inventory does not qualify for exchange treatment. After the property has been converted to a primary residence and all of the criteria are met, the property that was acquired as an investment through an exchange can be sold utilizing the Universal Exclusion.
Within the Qualifying Use Period, in each of the two, 12 month periods, the taxpayer must rent out the investment for 14 days or more to another person at fair market rental value. The most common scenario for a 1031 exchange involving multiple properties arises when an investor sells one valuable property and trades up to multiple rental properties. Markets that have seen high appreciation over the past decade or two — especially California, Hawaii, New York, and Washington — have seen a rise in these exchanges. In a 1031 Exchange, the relinquished property’s sales price less its modified adjusted basis is your realized gain.
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