In a 1031 tax deferred exchange, what amount of personal use is acceptable? If a vacation rental property is held for investment, how many days can the titleholder use for their family? A 1031 exchange is a well-documented tax deferral strategy recognized by the Internal Revenue Code (IRC) Section 1.1031. The theory is when a taxpayer, either domestic or foreign, sells real or personal property held in a trade, business or for investment and reinvests the sales proceeds and debt retired, their economic position has not changed. The taxpayer has not received the realized gain in the form of cash or reduced debt; consequently it would be unfair for a capital gain and recaptured depreciation tax to be paid. The gain is deferred when the replacement property is sold. When sold (and another 1031 exchange is not initiated), the original deferred gain plus any additional gain realized since the purchase of the replacement property is subject to tax.
1031 Exchange Property
Real, tangible and intangible personal property held for the proper intent in a trade, business or investment is eligible for 1031 consideration. A partial list of real and personal property includes vacation and single family rentals, apartments, commercial buildings, land, mobile home parks, thirty year leases, improvements to be constructed, cooperative apartments and easements. Aircraft and engines, ships, automobiles, buses, trucks, railroad cars, locomotives, furniture, equipment, precious metals, numismatic coins, livestock, artwork and vintage cars are also eligible for a 1031 exchange as are fishing permits, major league sport contracts, patents, copyrights, software, designs and drawings.
Intent and Facts
Each 1031 exchange has an intent and facts that support the intent. Proper intent is to hold the property for productive use in a trade, business or for investment. Applicable supporting facts include:
- the length of the hold
- how the property was itemized on the taxpayer federal tax return
- log of activity including expenses to maintain the property and insurance
- amount of personal use
Personal Use
Clearly, proper intent does not preclude personal use. Though if property is used primarily for personal use, such as a primary residence or second home, aircraft, car, truck or equipment, then the property is not eligible for a 1031 exchange. Property use can always be converted to investment or business use, given time as one of the qualifying factors.
Revenue Procedure 2008-16 provides a safe harbor where the IRS will not challenge whether the vacation home qualifies as property held for productive use in a trade or business or for investment under IRC Section 1031. Under the safe harbor, a vacation property qualifies if it is owned by the taxpayer for at least 24 months prior to the exchange and in each of the two twelve month periods, the taxpayer rents the property at fair market rent for 14 days or more and the taxpayer’s personal use does not exceed the greater of 14 days or 10 percent of the number of days during the twelve month period the property is rented at fair market rent. Personal use includes time used by relatives and friends and when not rented at fair market rent.
The replacement property test is similar to the one described above for the relinquished property, including a 24 month hold time and in each of the two twelve month periods, the property is rented at fair market rent for 14 days with personal use not exceeding 14 days or 10 percent of the number of days during each twelve month period.
Additional taxpayer use beyond the 14 days and 10 percent may be allowed for annual maintenance and repairs when the taxpayer spends the majority of the day working on the property.
Personal use must be minimal for the property to qualify for a 1031 exchange. Collectors should read the following articles on how to manage the inherent personal use component.
- 1031 Artwork and Collectible Best Practices
- 1031 Exchange: Collectibles – Artwork, Vintage Motorcars, Coins
We Can Help
Atlas 1031 Exchange has been accommodating tax-deferred exchanges of all kinds for more than 17 years. We are fluent in the rules and regulations of IRC Section 1031 and able to help you navigate your exchange.
Contact us today to discuss any questions you may have. Call our office at 1-800-227-1031, email us at info@atlas1031.com, or submit your question through the online form at the top of this page.
