Can You Use a 1031 Exchange for a Vacation or Second Home?

It depends on how you use it. A vacation or second home that you mostly use yourself doesn't qualify, because it isn't held for investment. A property that's rented out with limited personal use can qualify.

To give owners clearer guidance, the IRS created a safe harbor for vacation and second homes. Meeting it is the strongest way to show the property was held for investment.

The safe harbor for a property you're selling

To exchange a vacation home you own, you need to have owned it for at least 24 months before the sale. In each of the two 12-month periods before the sale:

• You rented it to others at fair market rent for at least 14 days, and

• Your personal use was no more than 14 days, or 10% of the days it was rented at fair market rent, whichever is greater.

Personal use includes days used by you, your family, or anyone paying less than fair market rent.

The safe harbor for a property you're buying

The same test applies on the other side. If you exchange into a vacation property, you need to own it for at least 24 months after the purchase and meet the same rental and personal use limits in each of those two 12-month periods.

In other words, you can exchange into a property you'd like to enjoy later, but for the first two years it has to be run primarily as a rental.

Falling outside the safe harbor

The safe harbor isn't the only way to qualify, but it's the clearest. If your situation doesn't fit it, the question becomes whether the facts show the property was really held for investment. That's a conversation to have with your CPA before you list, not after.

Moving into the property later

Some owners plan to eventually make an exchanged property their primary residence. That can work, but there are two rules to know.

First, your intent when you buy matters. Moving in shortly after the exchange can put the exchange at risk.

Second, if you later sell a property you acquired through a 1031 exchange, you have to own it for at least five years before you can use the home-sale exclusion. Even then, the exclusion is reduced for the years it was a rental, and depreciation you took is still taxed.

Keep good records

If you're relying on the safe harbor, keep records of every rental: leases or booking confirmations, rent received, and a calendar of personal use. Those records are what support the exchange if it's ever questioned.

Thinking about selling a vacation property?

Talk with your CPA about whether your property meets the safe harbor, and reach out to us before you go under contract. We'll get your exchange set up with your closing agent ahead of closing.

APX 1031 is a Qualified Intermediary. We don't provide tax or legal advice; talk with your CPA or attorney about your situation.