It’s that point of 12 months once more. Everybody is considering their summer season plans and spending time on the seashore. Whether or not your seashore is Easthampton or Spring Lake, traders ought to learn this text to make sure that ought to they ever want to promote their trip residence they’ve the choice of receiving favorable tax therapy. The tax penalties will be significantly crucial on the time a property is bought, since many trip locations have appreciated considerably and property house owners could also be going through vital capital achieve tax penalties upon disposition. Using a tax deferred trade below IRC Part 1031 will be significantly vital in disposing of such property.
Tax Therapy at Disposition: Qualifying for a 1031 Trade
Inner Income Code Part 1031 could also be out there for trip property house owners searching for to defer capital achieve taxes on the sale of a vacation-type property. The primary situation, generally, is whether or not the properties sought to be exchanged are held “for the productive use in a commerce or enterprise or for funding,” or whether or not they’re held completely for the non-public use of the taxpayer. The place to begin in addressing this situation is Income Process 2008-16.
Rev. Proc. 2008-16 creates a “secure harbor” for exchanges of trip property; in different phrases, if the required possession and use necessities of Rev. Proc. 2008-16 are met, the property will qualify below Part 1031. Underneath Rev. Proc. 2008-16, a “dwelling unit” is outlined as any actual property improved with a home, condominium, condominium, or related enchancment that gives fundamental dwelling lodging, which embody a sleeping house, lavatory and cooking services (e.g., a residential property). The secure harbors for the relinquished property and for the alternative property are considerably the identical. The IRS is not going to problem whether or not a relinquished dwelling unit, or a alternative dwelling unit, qualifies as Part 1031 property if:
The relinquished property is owned by the property proprietor for at the very least 24 months instantly previous to the trade, or the alternative property is owned for at the very least 24 months instantly after the trade (the 24-month interval, whether or not for the relinquished property or the alternative property, is known as the “qualifying use interval”); and
Inside every of the 2 12-month intervals which make up the qualifying use interval (whether or not for the relinquished property or the alternative property):
The property proprietor rents the property to a different individual or individuals at a good rental for 14 or extra days; and
The property proprietor’s private use of the dwelling unit doesn’t exceed the better of: 14 days, or 10% of the variety of days the dwelling is rented out.
Underneath Rev. Proc. 2008-16, private use of a dwelling unit happens on any day by which the taxpayer is deemed to make use of the property for private functions, as outlined below Part 280A(d)(2).
Rev. Proc. 2008-16 discusses Barry Moore v. commissioner, T.C. Memo. 2007-134, a 2007 Tax Court docket choice, which offers a very good instance of what’s going to not qualify for a 1031 trade of a trip property. In Moore, the property house owners exchanged a lakefront trip property for one more lakefront property. The property house owners argued that each of those properties had been held for funding due to the potential for long-term appreciation, and thus certified for tax deferral below Part 1031. Nonetheless, the court docket concluded that neither property was held primarily for funding functions, however had been as a substitute held for his or her private use and delight. In reaching this conclusion, the court docket thought-about that:
The property house owners by no means rented or tried to lease the property to others;
The property house owners deducted mortgage curiosity as a “residence mortgage curiosity” expense relatively than funding curiosity expense; and
The property house owners didn’t take (and doubtless didn’t qualify for) depreciation or different tax advantages related to an funding property together with deductions for upkeep bills.
Rev. Proc. 2008-16 offers a secure harbor for qualifying trip houses for functions of Part 1031, and assembly its necessities is probably going crucial to qualifying a trip residence below Part 1031. Property that doesn’t meet the necessities of Rev. Proc. 2008-16 will probably not qualify as relinquished or alternative property below Part 1031.
Changing a Trip Dwelling into an Funding Property
A property proprietor can put together prematurely for a possible Part 1031 trade sooner or later by changing a trip residence or second residence right into a property held for funding. There are a selection of steps that may be taken to perform this, which can embody a few of the following actions:
Conserving any private use of the property to a minimal, below 2 weeks a 12 months, and/or under 10% of the times the property is rented.
Leasing the property as a lot as possible given its location;
Retaining written data of all leases, leasing actions and listings for lease;
Hiring an area property administration firm to make the property out there for rental use;
Itemizing the property for rental on standard web sites equivalent to VRBO.com, leases.com, homeaway.com, vacationrentals.com, and so forth.; and
Exhibiting rental revenue and bills on Schedule E of the property proprietor’s tax return and different tax therapy in keeping with a rental funding property.
As all the time, you will need to seek the advice of together with your authorized or tax advisor earlier than partaking in a Part 1031 trade. A cautious assessment of the distinctive information and circumstances of a trip property proprietor’s scenario ought to be executed earlier than the choice is made to proceed with an trade.
Pamela Michaels, Esq., is sr. vp with Asset Preservation, Inc., New York, N.Y.