IRS Provides Safe Harbor Guidance on §1031 Treatment of Vacation Homes

By J. Bradley Campbell, Cherry, Bekaert & Holland, L.L.P. (CB&H)
Email: bcampbell@cbh.com

On February 15, 2008, the IRS issued Revenue Procedure (Rev. Proc.) 2008-16 establishing safe harbor guidance on the exchange of a vacation home for another real property investment under IRC §1031. This is welcome news indeed as guidance in this area has been scarce, forcing taxpayers to operate without clear, definitive answers to many questions.

Effective for like-kind exchanges that occur on or after March 10, 2008, Rev. Proc. 2008-16 finally provides some clear direction to help taxpayers determine whether their real property qualifies as property held for productive use in a trade or business, or as property held for investment under IRC §1031. It's important to note that all other requirements under IRC §1031 must be satisfied to maintain eligibility.

According to this new guidance, a vacation home can qualify as relinquished property under IRC §1031 if the taxpayer owns the property for a "qualifying use period" of at least 24 months immediately before the exchange. A vacation home can qualify as replacement property under IRC §1031 if the taxpayer owns the property for at least 24 months immediately following the exchange.

Within the consecutive 12-month periods specified under each of these qualifications, the property must be rented by the taxpayer to another person at fair rental value for 14 days or more, and the personal use of the property by the taxpayer cannot exceed the greater of 14 days or 10 percent of the number of days that the property was rented each year.

Personal use of the property includes use by the taxpayer, an individual with any ownership interest in the property, or a family member that does not rent the property as a principal residence at fair market value. Moreover, any rental agreement that does not comply the "fair rental value" guidelines would be classified as personal use under Rev. Proc. 2008-16.

Careful planning and documentation is required to support the like-kind exchange of a vacation home under IRC §1031, especially in any situation that falls outside of the guidelines set forth in Rev. Proc. 2008-16. Contact your local CB&H tax advisor to help you review your real estate tax strategy in light of this new guidance.

Brad is a Tax Partner with CB&H and Director of the CB&H Real Estate & Construction Industry Group.