Personal Use and Maintenance in a 1031 Exchange

Maintenance, personal and related party use issues surface when owning an investment property either acquired in or when owning a relinquished property with the intent to initiate a 1031 exchange when selling. Proper 1031 intent is to hold the real property, in the productive use of a business or for investment versus holding primarily for personal use. Facts support the investment intent such as how the property is reported on the taxpayer’s federal tax return, was the property in a rental pool and whether personal use exceeds the 14 overnights or ten percent of the rental days per year for real property.

1031 Exchange

An Internal Revenue Code (IRC) Section 1031 tax deferred exchange allows the taxpayer to defer the federal, state capital gain and recaptured depreciation taxes triggered when selling property held primarily in a business or for investment when replaced with property of equal or greater value held in a business or for investment. The tax deferral has many rules, such as the same taxpayer requirement, 45 and 180 calendar day timeframes and g(6) limitations of the code, requiring a qualified intermediary to hold the exchange funds in a manner such that the taxpayer does not receive, pledge, borrow or otherwise obtain the benefits of the exchange proceeds other than towards the purchase of replacement property. If exchange funds remain post completion of the 1031 exchange, the funds are conveyed to the taxpayer and taxed accordingly.

Personal Use

In Revenue Procedure 2008-16, applicable for exchanges on or after March 10, 2008, the Internal Revenue Service (IRS) provides a safe harbor test for vacation properties and second homes that should the taxpayer satisfy, the IRS will not challenge whether the vacation home qualifies as property held for productive use or investment. If outside of the safe harbor test, the taxpayer should be prepared to decisively substantiate that profit is the primary motive for owning the vacation property.

IRC Section 280A(d)(2), the IRS qualifies personal use as when a dwelling unit (real property defined as a house, apartment, condominium or improvements that include living accommodations such as cooking, sleeping and bathroom facilities) is used principally for personal purposes. The code further stated that the taxpayer has used the property if it is used by (i) the taxpayer or any other person who has an interest in such unit, or, by any member of the family of the taxpayer or such other person; (ii) by any individual who uses the unit under an arrangement which enables the taxpayer to use some other dwelling unit (whether or not a rental is charged for the use of such other unit); or (iii) by any individual, unless it is rented for fair rent, as determined by the facts and circumstances.

Related party use is considered to be taxpayer personal use. A related party includes the taxpayer’s family, such as brothers and sisters independent whether whole or by half blood, spouse, parents and lineal descendants, but not aunts and uncles, nephews and nieces, in-laws, stepparents or domestic partners. The exception is that a related party can rent property as their principal residence per Section 280A(d)(3) at fair market value. Consequently, a taxpayer’s child or family member can rent as their primary residence, but not as a vacation property without impacting the taxpayer’s personal use even at fair market value.

Maintenance

Though regulations have not been issued for maintenance, Section 280A(d)(2) provides that the Secretary of Treasury will establish regulations for use of unit for repairs and annual maintenance. Should the taxpayer be employed to provide repair and maintenance for the entirety of any day, the IRS will not treat as being used for personal use by the taxpayer independent if the property is rented.

Exchanges are recognized by the IRS as an approved strategy to defer capital gain tax. If you are considering the sale and replacement of property and have questions regarding how your tax deferred exchange would work, contact our office or click on the button above to ask a question or being your consultation.

 

 

FCC TV License Auction and 1031 Exchange

The Internal Revenue Service (IRS) has ruled the Federal Communication Commission (FCC) television and radio licenses with spectrum rights containing bandwidth differences are like-kind, or eligible for a 1031 exchange, because they were not different in nature and character, but merely grade and quality, per Private Letter Ruling 200532008. Television (TV) stations are assigned licenses with different frequency bandwidths. These licenses are being auctioned by the FCC along with other actions to free up more spectrum for broadband users by incentivizing license holders for certain TV stations to sell their rights in a FCC auction. When sold, the sole underlying property is the assigned frequency of the electromagnetic spectrum known as a FCC TV license. In Technical Assistance Memorandum 200035005 and Private Letter Rulings 8321127 and 8340041, the IRS allowed the exchange of a TV license for a radio license.

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1031 Exchange and Family Use

A 1031 exchange is fraught with rules and requirements that, if not followed can result in an IRS audit, penalty and tax bill. Known as a like-kind exchange, the Internal Revenue Code (IRC) Section 1031 allows the deferral of federal and state capital gain and depreciation recapture when property either real or personal held in the productive use of a business or for investment is exchanged solely for property held for productive use in a business or for investment. The 1031 exchange effectively postpones the payment of the tax until the replacement property is sold and another 1031 exchange is not initiated. The strategy is recognized by the Treasury Department and enforced by the Internal Revenue Service.

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Taxpayers Wish Their Realtors Know About a 1031 Exchange

Realtors and 1031 Exchange“Are you familiar with a 1031 exchange?” is a question that more taxpayers wish their Realtors would ask them when they are considering the sale of a property not held as their primary residence. Is it the Realtor’s responsibility to ask? Not necessarily; however, the Realtor is one, in addition to the taxpayer’s CPA, to be in a unique position to suggest that the taxpayer add a 1031 exchange to their list of topics to consider.

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Capital Gain 1031 Carryover and Converted Primary Residence Sale

The landscape quietly changed for investment property acquired in a 1031 exchange later to be converted and sold as a primary residence by the American Jobs Act of 2004. Internal Revenue Code Section 121(d)(11) was amended per section 840 of the 2004 legislation for the property acquired as replacement property in a 1031 exchange, rented for two years, converted and later sold as a personal residence.  The Section 121 $250,000 ($500,000 for married filing jointly) exclusion requires that the property be held for five years beginning on the date of acquisition in the 1031 exchange. The exclusion does not apply to that portion of the gain from the sale of the property that is allocable to periods of “nonqualified use” or time held not as the taxpayer’s principal residence and depreciation recapture.

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CPA 1031 Exchange Insight

A 1031 exchange allows the taxpayer to defer federal and state capital gain and depreciation recapture taxes when selling and replacing property held in the productive use of a business, trade or for investment. The taxpayer’s CPA should always be asked to quantify the tax consequences of the transaction, which represents one of the most important taxpayer’s criteria to evaluate when considering whether or not to initiate a 1031 exchange. Ultimately, when the 1031 exchange is reported to the Internal Revenue Service on form 8824 along with the taxpayer’s federal return, the CPA will provide the details of the 1031 exchange and affix their signature.

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