Cape Cod Real Estate, Properties for Sale, Vacation Rentals:

1031 Exchange

 

To qualify for a Section 1031 Exchange, both the Relinquished (sold) property and the Replacement (acquired) properties must be “used in a trade or business, or held for investment.” The most common questions we receive from Real Estate professionals regarding Section 1031 Exchanges relate to this ‘Qualifying Use’ issue:

 

1.    How long must I have owned my property before it qualifies for a 1031 Exchange;

2.    How many days can I personally use my second home and still have it qualify for an  exchange;

3.    For how long must I rent my property to others for it to qualify for a 1031 exchange;

4.    Am I required to rent my replacement property or limit its personal use;

5.    When can I move into my Replacement Property and convert its use to a principal residence without risking the validity of my exchange?

 

Until recently, it was difficult to provide a definitive answer to these questions, as there was very little guidance from the IRS regarding the Qualifying Use issue. Effective March 10, 2008, Rev. Proc. 2008-16 creates a safe harbor under which the IRS will not challenge whether or not a dwelling unit meets the Qualifying Use requirement under Section 1031: 

 

The Relinquished Property meets the qualifying use safe harbor if (A) it is owned by the taxpayer for at least 24 months immediately preceding the exchange, and (B) in each of the two 12-month periods immediately preceding the start of the exchange, (i) the owner rents the property to another person at a fair market rental for 14 days or more, and (ii) the owner's personal use of the property does not exceed the greater of (a) 14 days, or (b) 10% of the number of days during the 12-month period that the property is rented at a fair market rental.

 

The Replacement Property meets the qualifying use safe harbor if (A) it is owned by the taxpayer for at least 24 months immediately after the exchange, and (B) in each of the two 12-month periods immediately after the exchange, (i) the owner rents the replacement property to another person at a fair market rental for 14 days or more, and (ii) the owner's personal use of the property does not exceed the greater of (a) 14 days, or (b) 10% of the number of days during the 12-month period that the property is rented at a fair market rental.

 

Please note that these are safe harbor guidelines only and failure to meet these guidelines will not necessarily disqualify a property from a Section 1031 exchange. The guidelines will, however, enable many property owners to know with certainty that their properties will qualify for a 1031 exchange, and that this qualification will not be challenged by the IRS. 

 

It is always advisable for property owners to review the facts and circumstances of their ownership and use of a business or investment property with a tax advisor when considering a Section 1031 exchange.