New IRS Ruling Allows Minor Personal Use of 1031 Exchange Property

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Like-kind exchanges are great ways to defer the gain on highly-appreciated assets or real estate properties. The process is relatively simple: if it’s an asset, it must have been used in a trade or business; if it’s a real estate property it must be an investment property. In either case it must be exchanged for a similar asset. Because the real estate must be investment property, you can’t 1031 your personal home. So, how do you treat a vacation home that you use occasionally and rent out for all or part of the remainder of the year?

The IRS has just released a new ruling on this issue, that gives some relief to people in exactly that situation. Effective March 10, 2008, there is a new “safe harbor” provision that sets out exactly how much time you can spend in a second home that you also rent out, and still qualify to 1031 that home.

Under the safe harbor provision, a residence will qualify if:

  1. You’ve owned it for at least 24 months immediately before the exchange;
  2. In each of the two 12-month periods immediately before the exchange you: (a) rents out the property at fair market value for 14 days or longer, and (b) you don’t stay in the home for more than 14 days or 10% of the time the home is rented out, whichever is greater.

The safe harbor provision also goes the other way, for property than you want to roll into.

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