Asset Preservation Inc.
Lastly, the climate is starting to interrupt right here in New England! Everybody seems to be enthusiastic about their summer season plans and spending time at a seashore on Cape Cod, Newport, Outdated Orchard or on Lake Winnipesaukee. Buyers ought to learn this text to make sure that in the event that they ever wish to promote their trip house, they’ve the choice of receiving favorable tax remedy. The tax penalties might be significantly important on the time a property is offered, since many trip locations have appreciated and property house owners could also be going through important capital acquire tax penalties upon disposition. Using a tax deferred alternate below IRC Part 1031 might be significantly necessary in disposing of such property—if such property can qualify as “held for funding”.
Tax Therapy at Disposition: Qualifying for a 1031 Trade
Inside Income Code Part 1031 could also be accessible for trip property house owners looking for to defer capital acquire taxes on the sale of a vacation-type property. The primary difficulty, usually, is whether or not the property to be exchanged is held “for the productive use in a commerce or enterprise or for funding,” or whether or not held solely for the non-public use of the taxpayer. The start line in addressing this difficulty is Income Process 2008-16.
Rev. Proc. 2008-16 creates a “protected harbor” for exchanges of trip property; in different phrases, if the desired possession and use necessities of Rev. Proc. 2008-16 are met, the property will qualify for tax deferral below Part 1031. Underneath Rev. Proc. 2008-16, a “dwelling unit” is outlined as any actual property improved with a home, house, condominium, or comparable enchancment that gives primary residing lodging, which embrace a sleeping area, lavatory and cooking amenities (e.g., a residential property). The protected harbors for the relinquished property and for the alternative property are considerably the identical. The IRS won’t problem whether or not a relinquished dwelling unit, or a alternative dwelling unit, qualifies as Part 1031 property if:
1. The relinquished property is owned by the property proprietor for no less than 24 months instantly previous to the alternate, or the alternative property is owned for no less than 24 months instantly after the alternate (the 24-month interval, whether or not for the relinquished property or the alternative property, is known as the “qualifying use interval”); and
2. 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 particular person 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 higher 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 through which the taxpayer is deemed to make use of the property for private functions.
Rev. Proc. 2008-16 discusses Barry Moore v. commissioner, T.C. Memo. 2007-134, a 2007 Tax Courtroom choice, which supplies a very good instance of what’s going to not qualify for a 1031 alternate of a trip property. In Moore, the property house owners exchanged a lakefront trip property for an additional 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. Nevertheless, the tax 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 “house mortgage curiosity” expense, quite 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 supplies a protected harbor for qualifying trip houses for functions of Part 1031, and assembly its necessities is probably going important to qualifying a trip house below Part 1031. A trip property that doesn’t meet the necessities of Rev. Proc. 2008-16 will seemingly not qualify for Part 1031 alternate tax deferral.
Changing a Trip or 2nd Dwelling into an Funding Property
A property proprietor can put together prematurely for a possible Part 1031 alternate sooner or later by changing their trip house or second house right into a property held for funding. There are a selection of steps that may be taken to perform this, which can embrace a number of the following actions:
• Preserving any private use of the property to a minimal, below two weeks a 12 months, and/or beneath 10% of the times the property is rented.
• Leasing the property as a lot as possible, given its location;
• Retaining written information of all leases, leasing actions and listings for lease;
• Hiring a neighborhood property administration firm to make the property accessible for rental use;
• Itemizing the property for rental on common web sites equivalent to VRBO.com, leases.com, homeaway.com, vacationrentals.com, and many others.; and
• Exhibiting rental earnings and bills on Schedule E of the property proprietor’s tax return and different tax remedy according to a rental funding property.
As all the time, it is vital for taxpayers to seek the advice of with their tax and authorized advisors earlier than partaking in a Part 1031 alternate. A cautious evaluation of the distinctive details and circumstances of a trip property proprietor’s scenario must be achieved earlier than the choice is made to proceed with a 1031 alternate.
Lynne Bagby, CES, is the New England division supervisor for Asset Preservation, Inc., Boston.