When a Vacation House Won’t Qualify for a 1031 Exchange

A 1031 exchange is an intelligent way to buy and sell real estate properties for investment purposes. This measure allows you to defer your tax obligation as a consequence of the sale.

However, a 1031 exchange is hard to execute when a vacation house is in question, especially when there is Tenancy in Common (TIC) agreement. At times, proving that this piece of real estate is truly used for business, not for personal use, can be tricky. A vacation house that’s also a TIC property involving many stake owners further complicates the process,

To successfully swap your vacation house or TIC property for another piece of real estate, you must follow the “safe harbor” guidelines set by the Internal Service Revenue (IRS) and seek the services of companies like 1031 Exchange Place. Otherwise, you’ll likely be challenged by the tax-collecting agency.

Here are the mistakes you should avoid.

Using It for Over 14 Days a Year

Using your vacation house for personal enjoyment doesn’t automatically disqualify your property for a 1031 exchange. However, you should avoid personally using it more than 14 days or 10% of the rental period per year — whichever is greater. Limiting any non-business-related use of the vacation house would establish that it’s more of an investment than a personal residence.

Again, this requirement is hard to achieve when many individuals have a percentage stake in the property. The IRS may take a closer look at your 1031 exchange to ensure that this rule has been followed.

Renting It Out for Less Than 14 Days a Year

To qualify as an investment property, a vacation house must provide rental income. Fortunately, the IRS doesn’t need to see all-year occupancy. For as long as you rent it out to a legitimate tenant for a minimum of 14 days within every 12 months within the two years immediately preceding the 1031 exchange.

Charging at Less Than Fair Market Value

Renting a vacation house is one thing, but charging the qualified amount of rent is another. You can’t collect rent below the fair market value to make it appear that your property is used as a vacation house. The IRS will challenge your exchange if you can’t prove that you didn’t charge tenant discounted rental rates.

Having a Primary Residence Mortgage

Woman signing contract

A primary residence mortgage is a common deal breaker. The IRS wants to see that an investment loan was taken out to obtain the vacation house, which establishes that it’s being used for trade. Any non-investment mortgage on the property will suffice to disqualify you for the 1031 exchange.

Claiming No Deductions for Maintenance

Deducting home improvements for maintenance reasons is a convincing way of showing the IRS that you’re treating the property as an investment. If you consider roof replacement or mold removal as business expenses, you can better prove your investment intent.

Owning It for Less Than 24 Months

You also need to own the vacation house for 24 months immediately preceding the exchange. Anything less will automatically disqualify you.

Swapping a vacation house for another real estate property through a 1031 exchange is usually difficult. But with the help of a qualified intermediary, you can abide by the “safe harbor” rules successfully and time your exchange thoughtfully.

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