One of the most common questions asked is whether or not a vacation property qualifies for a 1031 exchange. There are three basic rules for including a vacation home in a 1031 exchange that were introduced by the IRS in 2008.

A vacation home can qualify — but only if it meets three specific IRS tests. Getting the details right is critical, and professional legal counsel is strongly recommended.

Rules for Vacation Home as Relinquished Property

For a vacation home to qualify as relinquished property in a 1031 exchange, all three of the following conditions must be met:

Three-Part Test for Relinquished Property

  • The vacation home must have been held by the taxpayer for a minimum of 24 months immediately preceding the exchange.
  • The vacation home must have been rented at fair market value for at least 14 days in each of the two 12-month periods.
  • The property owner cannot have used the vacation home personally for more than 14 days or 10% of the days the home was rented out (whichever is greater) within both 12-month periods.

Rules for Vacation Home as Replacement Property

The rules for a vacation home as a replacement property are the same requirements — applied going forward. The property must be held for a minimum of 24 months after the close of the exchange; the property must be rented out at fair market value for at least 14 days in each 12-month period; and the taxpayer cannot use the vacation home for personal use more than 14 days or 10% of the days it was rented out (whichever is greater) in each 12-month period.

The Maintenance Exception

There is one small exception to the days a taxpayer can use both the relinquished and replacement properties. The taxpayer can use the home for personal use above and beyond the 14 days or 10% limit, if the overage was used exclusively to complete improvements or maintenance on the property.

If a taxpayer plans to utilize this exception, they should keep all receipts of maintenance or improvements completed during the duration of their stay, to ensure compliance with the regulations upon IRS scrutinization.

Our Recommendation

Following the rules above, a vacation property can be eligible property for a 1031 exchange. It is strongly recommended that any taxpayer contemplating a 1031 exchange involving vacation property discuss the transaction with their tax and legal counsel before proceeding. The rules are nuanced and the consequences of getting it wrong are significant.