I was at a wedding this weekend, and was talking with a friend who was working on disposing properties on behalf of a trust for an elderly friend. The elderly woman is now in assisted living, so two properties are involved. The primary residence has already been fixed up and put on the market.

Here is where we need help. She has a vacation home in Sag Harbor, NY, that she has not been to in many years. It has never been used as a rental or a primary residence. It was bought in 1984 for $40,000 - and would appraise for $900K today. 

I suggested a 1031 exchange - as the parties would be ok with trading for a property of similar or higher value much closer to where the elderly friend resides. She does not need the money from the sale of the vacation home, and would be willing to trade it for something that could be a rental and easy to get to - which will probably be on the Jersey Shore.

So I have read all of the rules on the 1031 exchange - including the articles on BP. My friend says she contacted her attorney - and said that the vacation property would have had to been used as a rental for 2 years before qualifying for 1031 treatment.

What say you? Does a property HAVE to have been a rental to qualify for a 1031 exchange? My position is that it has been an investment property simply through the huge equity gain over the years...

This property is in NY - do they have special rules?

Look forward to hearing from the experts. Thanks!

You have to prove to the IRS that has been an investment property by showing a lease. 

The attorney is correct, the property would need to be rented for a period of time.  The IRS has issued letters stating vacation property is not eligible for 1031 exchange.  They could rent it and wait two years, but if they sell it now they will take the taxable gain.  

@Thomas Force , Any property held with the intent of productive use in business trade or for investment can be exchanged.  

Rental property is always considered investment but is not the definition of investment.  In fact, holding for investment appreciation is also considered investment.  Actual rental is not a requirement.  Raw land not actively developed is always considered an investment.  Actual income is not a requirement.  

It may be that the property really wasn't an investment property and was only a second home with no investment intent.  But it may be that the property was held for investment appreciation and the face that she has not used it for a long time for anything other than to hold like raw land is demonstration of that intent.

What they are reporting from the attorney is a "safe harbor definition from rev proc 2008-16.  It is not the only definition but it is a safe harbor.  So the attorney either doesn't get the nuance within a "safe harbor" or more likely they understand her total picture better and know her situation.

Thank you all for the info. Will pass along to my friend and I know she appreciates all of your insight. I do as well. Thanks!