A like-kind exchange, or 1031 exchange, is simply the exchange of two like-kind properties with the intention of deferring the tax of the sale. Like-kind simply means properties that are considered to be the same type.
In a 1031 property exchange, like-kind refers to property that is being held for investment, or income producing. Land, for example, is always considered an investment which the IRS will not question. Another example would be a commercial property, such as an office building or owning a retail space.
With residential properties such as a home or condo, the IRS may look a little closer to determine if the taxpayer’s “intent” was to hold the property for investment. A primary or secondary residence only occupied by the taxpayer would not be considered held for investment because it is not income producing and the taxpayer is claiming that property as a personal residence, as opposed to held for investment.
For a residential property to be considered held for investment by the IRS, the best indicator to them is that the property needs to be income producing. This means that the property should be rented out to tenants during the time you have title to the property. To help form guidelines, the IRS came out with Rev. Proc. 2008-16 which tells us how they will determine if a residential property is held for investment.
In Rev. Proc. 2008-16, or the Vacation Home “Safe Harbor”, a residential property is held for investment if with regards to the old AND the new property in the 1031 exchange is:
- Held for at least 2 years prior to the sale of the old property, and 2 years after the sale for the new property
- Rented out at least 14 days each year at fair market value
- Used for personal use for no more than 14 days or 10% of the total amount of days rented per year (i.e. if one year the property is rented out for 200 days, the taxpayer may use it personally for no more than 20 days in that same year)
If you are looking to do a 1031 exchange and are unsure if your property would qualify, please give us a call. The safe harbor rule is not as restrictive as you may think, and we can assist you in determining safe harbor!