Good news!  After years of strict interpretations, the IRS just issued Rev. Proc. 2008-16, which gives a new and broader definition of "dwelling units" and how they can qualify as  “like kind” real property.

In order for property to qualify for a Section 1031 tax-deferred Exchange, the property sold must have been held for productive use in a trade or business or held for investment purposes.  The property purchased as the replacement property must also be “like kind” and thus must also be held for productive use in a trade or business or for investment purposes. 

So where does that leave a vacation/second home?  Can it qualify for a Section 1031 Exchange?  There have been many interpretations answering this question.  More than 18 months ago, we discussed this very topic -- the vacation/second home issue -- in our August 30, 2006 blog.  The interpretation had been rather narrow and strict.

First, the technical information.  If a taxpayer owns a vacation/second home for at least 24 months immediately before the Section 1031 Exchange and rents the dwelling unit to another person(s) at a fair market rental for 14 days or more a year and uses it for personal use less than 14 days a year or 10 percent of the number of days during the 12-month period the dwelling unit is rented at a fair market rent, the property will qualify under Section 1031 for a tax-deferred Exchange. 

Whew--that was a long technical statement.  Please note the same rule applies for the property the taxpayer purchases as a replacement property if that is going to be a "dwelling unit.  I have a three letter word for this new Rev. Proc.---WOW !!! 

Now, let me give you a nontechnical interpretation.  A taxpayer who owns a vacation or second home for at least 24 months, uses it for 14 or less days a year, or less than 10% of the time it was rented in any of those years, can qualify that dwelling unit for a tax-deferred Exchange. 

The taxpayer doesn’t have to rent it out for an extended length of time, it could be rented for just 14 days a year and could qualify under this new Rev Proc.  What if the taxpayer was purchasing a replacement property  that was a "dwelling unit"?  The same rules apply, the taxpayer could then find a replacement property which would also have to be owned for 24 months, rented out for 14 days or more a year, etc.  But, again, there is no obligation to rent it out long term. 

This is a monumental change in the interpretation and is sure to benefit many vacation-second home owners.  It becomes effective March 10, 2008.   ~by Stephen A. Wayner

Stephen A. Wayner, Esq., CES brings over 35 years of real estate industry experience to his position as First Vice President of Bayview Financial Exchange Services, LLC, a Qualified Intermediary.