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Dear Tax Talk,
We own a second home in South Florida that we would really like to exchange for another home on the Gulf
Coast. The problem is that the home has appreciated quite a bit and we don't want to pay taxes on its sale and
lose that part of our equity. It doesn't seem right that we should when we're ending up in the same boat.
Does a vacation home qualify for the like-kind exchange rules that apply to rental properties?
-- Gary
Dear Gary,
The IRS recently clarified how a vacation home can qualify for a like-kind exchange. In a like-kind exchange,
the property owner avoids paying taxes on the relinquished property if he or she reinvests the proceeds in
similar property.
Because it is usually difficult to find someone to exchange property with directly, the like-kind
exchange rules are carried out through an intermediary. The intermediary sells your current home and uses the
proceeds to buy the replacement property that you have identified. If done properly, no taxable gain is recognized
and of course the property is deeded in your name. The fees of an intermediary are typically less than $1,000.
The like-kind exchange rules are limited to property held for investment or used in a trade or
business. The term "held for investment" has always been kind of vague in the vacation-home setting. While most
people buy a vacation home as some sort of investment, the courts and the IRS have always maintained that it has
not been the primary purpose and therefore have denied like-kind exchange status.
IRS Revenue
Procedure 2008-16, outlines a safe-harbor
set of facts that allows taxpayers to enjoy the
benefits of like-kind exchanges. In order to qualify,
a taxpayer has to rent at fair value the relinquished
and replacement property for more than 14 days
for two years prior to and two years after the
exchange.
In addition, for the same four-year
period, the taxpayer cannot use the property for
personal purposes for more than the greater of
14 days or 10 percent of the days that it is rented
at fair rental value. A taxpayer utilizing the
safe harbor in this revenue procedure also must
satisfy all other requirements for a like-kind
exchange under Section 1031.
This revenue procedure is effective for exchanges of dwellings occurring on or after March 10,
2008. No inference is intended with respect to the federal income tax treatment of exchanges of dwelling units
occurring prior to the effective date of this revenue procedure.
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