By Daniel E. McCabe,
ESQ., President
Investment Exchange Group, LLC

A common question our clients ask is whether their vacation or second home qualifies for a 1031 tax deferred exchange. The answer is "probably." This answer hinges on the actual use of the property by the owner.

There is no question that a rental property used fewer than 14 days a year by the owner, and rented out the rest of the year, is considered to be investment property and qualifies for a 1031 exchange. The unit may also be used by the owner for maintenance purposes without it becoming a personal residence.

But what if a vacation home is never rented out, but is held and used only by the owner and remains vacant when the owner is not there? Is it "investment property" for 1031 purposes?

The definition of qualified property in the Regulations* for Section 1031 reads as follows: "Unproductive real estate held by one other than a dealer for future use or future realization of the increment in value is held for investment and not primarily for sale."

This language was adopted by the IRS in 1956 and has remained unchanged since then. Thus, unproductive raw land with no improvements, held solely for purposes of realizing an increase in value, certainly qualifies for a 1031 exchange. But does personal use of the property as a vacation home by the owner disqualify it for a 1031 exchange?

In a 1981 Private Letter Ruling**, the IRS allowed Section 1031 treatment of a vacation home where the taxpayer intended to acquire property for personal enjoyment and as an investment. The IRS stated, "The house and lot you acquire in this trade will be held for the same purposes as the properties exchanged therefore: to provide for personal enjoyment of the community and to make a sound real estate investment." This Private Letter Ruling would seem to support the argument that "personal enjoyment" of a property does not prevent it from qualifying for a 1031 exchange.

*IRS Reg. 1.1031(a)1(b)
**Private Letter Ruling 8103117

Dan McCabe, Esq. is president of Investment Exchange Group, LLC which provides a full-range of services for §1031 tax-deferred exchanges, including legal consulting on complex exchange techniques. . He is a national speaker for 1031 exchanges and president-elect of Federation of Exchange Accommodators (FEA). IXG is located in Denver, CO with consultants in Arizona, Connecticut, Georgia, Florida, Hawaii, Oregon and Wyoming. Call 800.908.1031 for a free consultation or visit us at visit www.ixg1031.com.