Revenue Procedure 2008-16, effective March 10, 2008, provides a number of safe harbor guidelines that permit you to complete a 1031 of your vacation property or second home. It is important to note that Rev. Proc. 2008-16 only provides safe harbors and that a 1031 exchange of a vacation home or second home that falls outside of the safe harbor guidelines may still qualify for a 1031.
According to the Safe Harbor rule, both the relinquished and replacement property is considered held for investment if:
- Held for at least 2 years prior to the exchange for the old property, or 2 years after the exchange 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)
Note the words “personal use” in the third requirement of a safe harbor exchange. One question many folks ask us is if this includes days you’ve spent at the property preparing it for renters (i.e. buying furniture and supplies, doing improvements, making repairs, etc.). This is a great question, as many property owners know it can easily take more than 14 days per year to prepare a property for tenants. The answer is no—any days used to make improvements or prepare the property for tenants do not count towards your 14 days or 10% of total days rented that year. In order to prove that you spent those days making improvements and not relaxing by the beach, simply keep records, such as receipts, to show that your time spent that day to prepare your property for tenants.
Under these guidelines, you can be assured the IRS will not question if your properties in a 1031 qualify as held for investment. What if you have rented out your investment property, but don't meet these exact guidelines—is a 1031 exchange still possible? The answer is most likely yes. Safe harbor is just a strategy written by the IRS to keep you “safe,” but is not required for a 1031 exchange. To read more about vacation homes in a 1031 outside of the safe harbor guidelines, please visit here Vacation Homes and 1031 Exchange