Vacation Homes and IRC 1031s for Tax-Deferred Real Estate Exchange

In order to qualify for an IRC 1031 tax deferred exchange the property to be sold, the relinquished property, and the property to be purchased, the replacement property, must both be held for productive use in a trade or business or for investment purposes. When a taxpayer wishes to structure the sale or purchase of a vacation or second home as an IRC 1031 tax deferred exchange it is important to determine whether or not the property could be considered an investment property, even if there is no history of renting the property.

The Internal Revenue Service decided in Private Letter Ruling 8103117, that a taxpayer could acquire a vacation home where the acquisition reasons were stated as being for investment purposes as well as for personal enjoyment. The PLR states that “the house and lot you acquire in this trade will be held for the same purposes as the properties exchanged: to provide for a personal enjoyment and to make a sound real estate investment.” Accordingly, it may be possible to consider a vacation home as relinquished or replacement property when structuring an IRC 1031 tax deferred exchange.

The ruling takes into account the fact that it is not necessary for a property to be income producing in order for it to be considered an investment property. Treas. Reg. 1.1031(a)-1(b) states, among other things, that as long as the unproductive property is not held by a dealer, not held primarily for resale, and is held for “future use or future realization of the increment in value” it could be considered investment property. If a taxpayer researches the investment qualities of the acquisition of a vacation or second home it is possible that the property could be considered a viable 1031 property.

It is important to remember that only the taxpayer for whom the private letter ruling was given may rely on that particular ruling. There are no other rulings which provide authority or comfort for taxpayers wishing to do an exchange of a vacation home or second home. Taxpayers should consult with their tax or legal advisor to determine if their property will qualify.

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