Under Revenue Procedure 2008-16, which took effect March 10, a tax deferred exchange 1031, which allows the owner of a building investment to roll over gains into another "like" goods such investment, thereby delaying taxes on earnings, may now include personal vacation homes in certain circumstances. However, the personal use of a holiday home must officially be limited, bearing generally for personal use within 14 days per year or 10% of the time it is rented to others. The property must be held for investment with the expectation that it will appreciate in value.
Many houses "second or vacation" are actually investment properties because their owners lease them to the majority of the year. The IRS has avoided any other language for personal use on a free exchange Tax after a recent court case has generated a need for clarity.
In Moore vs. Commissioner, the taxpayers have exchanged a holiday home on Lake Georgia for another. Neither house was rented and used by the taxpayers only for personal use. Taxpayers have claimed exchange of the homes was a like kind exchange under section 1031, arguing that the appreciation in market value was valid justification for the establishment of a holiday home as an investment property.
The Tax Court however, deemed the property held for personal purposes and hope that the "simple or expectation that property may be sold at a gain can not establish investment intent if the taxpayer uses the property as a residence. "
According to Article 1031 Tax Code, no gain or loss is recognized on the exchange of property held for productive use in a trade or business or investment, if the property is exchanged solely for property of like nature to be held either for productive use in a trade or business or for investment. So far, individual homes can not be exchanged tax free under section 1031 because they are not held for productive use in a trade or business or for investment.
Second or Holiday Homes
While the IRS is fully aware that many people use their investment properties for their own pleasure, the Service is saying it will not appeal simply an exchange 1031 because there was personal use of an investment property. Recognition there may be a personal use is a totally new situation of the function.
In light of the Moore case, the IRS adopted a more lenient approach to exchanges. Although it now provides taxpayers with a safe harbor, they also gave us a checklist under direct which a dwelling will qualify as property held for productive use in a trade or business or for investment, for the purposes of section 1031, although they will occasionally use it for personal purposes.
The IRS will not challenge whether If a dwelling is permissible under section 1031 as property held for productive use in a trade or business or investment, as as other exchange rules are met.
Strict personal use of the investment property as a house "second" continue to apply. The Service has adhered to the standard in section 280A of the IRC for guidance. The length of personal use of taxpayer unit Housing can not exceed the greater of 14 days or 10 percent of the number of days during the 12 months that housing is rented at a fair market value.
The Moore missed the section 1031-tax-free exchange test for a variety of reasons, according to court tax. The taxpayers never rented or attempted to rent the properties. They did not offer the replacement property for sale until they are forced to do so by the need for liquidity in connection with the incident of the division of assets in their divorce. In addition, they have failed to claim tax deductions for maintenance expenses or depreciation connected with the properties and claimed interest deductions on both properties as home mortgage interest rather than as investment interest.
A tax advisor recommends that, to establish that the property is investment property, taxpayers should at least meet the requirements regarding the deduction of losses, but also go further in treating the property as real estate investments whenever possible. For example, record keeping for properties that are distinct in the records of the taxpayer for his personal residence may help to establish the intention to retain the property as property investment rather than for personal use.
In the Moore case, the taxpayers hoped that both properties would. However, the judge of the Tax found that the primary objective of taxpayers in the acquisition and possession of property was to provide resorts to character staff for their family.
Do not be afraid to use your beach house, Ski Lodge, or the French Quarter On Earth, even if investment property and you intend to exchange against another investment property on the road. If you limit your personal use, you will sail in port of new and safe from the IRS.
Contact me and I'll give my opinion on the conversion of property to property held for investment.
James P. McNamara is the Managing Principal of Exchange Equity, LLC. The Firm is a private real estate investment company that acts for its own account and for the account of co-investors in quality real estate properties that is headquartered in New Orleans, LA.
The Company created a Tenant In Common program to offer small and medium size investors, the opportunity to acquire the quality net-leased properties previously the exclusive purview of only the largest of institutional investors. The program is designed to accommodate the first time real estate investor looking to diversify their portfolio or for a passive investor looking to preserve and protect equity in a relinquished property exchange through an IRC §1031 Exchange.
For more information on the product, or to order online, visit http://www.exchangeequity.com or call 866-362-1031.
Media contact:
James P. McNamara
jamesp@exchangeequity.com
Phone: 504-897-1299
