Can you do a 1031 Tax-Deferred Exchange with a Vacation Home?

Did you know that you can sell your investment real estate and reinvest the gain, tax-deferred, to purchase your vacation home sanctuary? Maybe it's time to sell your apartment building or investment condominium and purchase property that you can truly enjoy. 

Hundreds of people who own property here on Maui and properties all around the US and US territories execute 1031 exchanges every year. We think that we've seen more this year than ever before. 

So, why would someone want to do an exchange for a vacation home?

Part of the ROI (return on investment) for a vacation rental property is FUN. Many of the people we work with bought here on Maui or a resort area on the mainland, like Tahoe or Monterey, years ago. They've enjoyed the property with friends and family and made a little money renting and may have significant appreciation. Now they just don't use the property as much and want to relocate that asset. 

Or maybe you want a better return on that asset. Many of our clients find that single-family homes or commercial real estate in certain mainland markets produce higher rates of return.

Last but not least, if the new tax laws have had a negative effect on your ability to write off certain expenses, such as local taxes, it might be time to reallocate to an investment which will result in better tax treatment.

The challenge is making sure the vacation home will qualify as a 1031 investment property. 

The IRS has specific rules regarding vacation homes. If you meet certain qualifying use standards, you may qualify for a tax-free exchange (section 1031 exchange). You may be able to sell your vacation rental property and buy another investment property - it does not have to be a vacation rental property.

To qualify as a "relinquished" property in a 1031 Exchange (the vacation property you are selling), you should have owned it for 2 years and be able to demonstrate that in each of those 2 years the property has been rented at fair market value for 14 days or more and personal use is limited to 14 days or less or no more than 10% of the number of days the property was rented. 

If you plan to buy another vacation property, your "replacement" property, you should plan to hold the property for 2 years after the exchange and rent it for 14 days or more each year and limit personal use to 14 days or less or no more than 10 percent of the number of rental days.

If you want to find out whether your situation qualifies, consult with your tax and legal advisors. If you would like to explore your options for reinvesting in a different type of investment property or relocated your investment to a different location, we can assist you in clarifying your goals and creating a strategic plan to meet them. 

Published in Neighbors of West Maui - September 2019