1031 possible for vacation/second home?

Question

We have had a second home for almost 2 years. The house is not a formal rental property even though we allow friends and family to use it. No rental fees are paid to us currently. However, this home is not our primary residence by any stretch.

We have gotten into rental properties over the past year and are wondering if we can use a 1031 exchange if we sell our second home and buy a true rental going forward.  Does the fact that the second home was not a true rental/investment affect the ability to use a 1031 process?

Thanks in advance for the input.

Jenni Villane · Answer

Thank you for the feedback.

Dave Foster · Answer

@Jenni Villane, There is not a statutory minimum.  There's a safe harbor for usage from the IRS that was originally designed to qualify your ability to deduct mortgage interest and depreciate the property.  But there is no bright line income amount.  It's all over the map for folks.  Your accountant will be a good gauge for you as they can assess how aggressive you are in the rest of your return.

It's always better to get the counsel of someone familiar with your entire picture.  From the 1031 perspective that is something that is never noted or seen.

Jenni Villane · Answer

@Dave Foster One other question, does it need to be a rental for a specific period of time? Thanks!

Dave Foster · Answer

@Jenni Villane, In order to qualify for 1031 treatment the property must be held with an investment intent. 2nd homes that are rented out or being held with an investment intent certainly qualify because the type of loan doesn't matter.  If you rented the property to friends and family (declared the income on your tax return for 2020, had leases collected money even if you give the money back as legal gifts) then that is an investment property and would be eligible for 1031 treatment.

It's all about the intent and how you demonstrate that intent.  We have numbers of clients with vacation homes and 2nd homes that they rent to friends and family and return the money so they can keep the property held as investment.