Court rules against 1031 Exchanges for vacation homes
In a decision on May 30, 2007, the US Tax Court denied like-kind exchange treatment (1031 exchange) for vacation homes unless they were used strictly for investment purposes. Many of my clients here in Summit County buy vacation homes recognizing that they will probably appreciate, knowing that they could be a great investment that they can enjoy themselves. They usually are a good investment, but now one will have to rent the vacation home, at least part of the time, or not be able to use the tax deferred treatment. Of course, one should always consult your tax advisor when intending to do any such thing and get the opinion of your expert in that field. In the past it has been a grey area, and some of my clients had tax advisors that told them it was probably ok, and others said “no way!”
A Georgia couple had performed a 1031 exchange with their vacation home, and the court issued a memo stating that the exchange did not qualify under the rules of the 1031 tax deferred exchange, finding that “the holding of any residence, even if motivated in part by an expectation that the property will appreciate in value, is insufficient to justify the classification of that property being held as an investment.”
The court said that” The mere hope or expectation that property may be sold at a gain cannot establish an investment intent if the taxpayer uses the property as a residence. ”
The entire ruling is available at www.ustaxcourt.gov/InOpHistoric/Moo8re.TCM.WPD.pdf.
June 5th, 2007 at 7:07 am
Joanne,
This is an important issue for all of us that work in the vacation market. I spoke with a client last night and they were concerned about their exchange because they had not rented their home for some time. One of the articles suggested that the consumer not use the property for some time but I would like to see some clarifications on that. Our market like yours is very seasonal and many owners use their property in the shoulder season. Consumers must consult professionals or pay the price of cutting corners.
June 5th, 2007 at 7:13 am
I think it is more a matter of deriving investment income from it than not using it. Rental income and the treatment on your income tax return (depreciation as an investment property) will assume more importance. Thanks for your input Ronnie!
June 8th, 2007 at 11:18 am
This is a very important case as this issue has needed some clarification. There is a tax law unrelated to 1031 that says a property used for personal reasons for 14 days or less a year or 10% of the number of days the property is rented (whichever is greater), can be considered an investment property. Although not specifically related to 1031 law, many professionals use it for a guideline.
A couple important things about this case can shed some lite. The court found that the PRIMARY reason they bought the property was vacation, second to that was investment intent for appreciation. I mean, they bought a boat to cruise around in, not good support. In another similar case awhile back a court approved the investment intention of a vacation home used in a 1031 with apprciation being the number one intention. The taxpayers there did not rent it out, but they also did not use it personally very often. So, as always counsult a tax advisor to look at the specifics, the devil is in the details.
June 8th, 2007 at 11:43 am
Thanks for your insight Jeff! It has been a grey area for a long time and don't even try to tell people if I think they can do a 1031 or not. It is not my area of expertise, and I refer them to people whose job it is to know.
September 26th, 2007 at 8:28 am
Joanne, this is a very delicate issue that must be handle by proffesionals. There are many gray areas, like you say, but still a great deal for sellers. I would encourage my clients to do a 1031 exchange if their property qualifies for it.
February 22nd, 2008 at 5:27 pm
[…] even though they don’t rent their properties, consider them investments. Last spring, a second home owner in Georgia lost a court case where they claimed just that, and now the IRS has become more specific. Here is some of what […]
June 25th, 2010 at 9:36 am
[…] to defer the taxes when you buy another property, but it can be tricky to do successfully. A recent court case helped to clarify this issue, and I would suggest talking to your tax advisor as it could be a […]
June 25th, 2010 at 10:08 am
[…] Real Property Use. Both your old and new properties must qualify as investment or business use. If both properties pass this test, you can exchange nearly any type of real estate. Read a blog post about a recent court ruling on 1031 exchange treatment of vacation properties. […]