We have our house in Lake Tahoe, California for 6 years for which in the past we've used a portion of the year as a vacation house (random weekend visits mostly, but a couple of summers we lived at the house), and had the house available on Airbnb for the rest of the year (majority). We are considering selling it in the near-ish future and want to know how we can defer capital gains tax by getting it to be classified as a rental/investment property so we can use a 1031 exchange?
Thanks in advance!
@Sandy Metivier , It's not your primary so that leaves the door open. As long as your accountant agrees that there was an investment intent. And if you've advertised, collected rent, declared rent and paid taxes on the income it would be hard to argue against that. Then your property would qualify.
The IRS has some safe harbor language regarding % of personal use. But that is just their outlier safe harbor. The standard truly is your intent and how you demonstrate that.
The type of financing on the property doesnt' matter. And there is no prohibition against personal use. It just needs to be treated as an investment property you spend a lot of time. in rather than a second home held as personal property.
Thank you @Dave Foster , that is super helpful.
When I ran this question by my CPA he said "That’s an interesting question you would talk to a tax lawyer about that it’s super complex let me know how it goes." -- This raises a flag for me, should he have been able to guide me better? Should I be looking for a new CPA, one that specializes in real estate?
Thoughts on this?
@Sandy Metivier , Well splitting an atom isn't complex for my son. But programming a vcr is for me. So I guess it's all relative. But it is your cpa who will use your tax return and how things are reported to help you determine the answer to this question. So, yeah it seems a little ...dodgy for your cpa who knows you to send you to a tax lawyer for a question they really ought to be able to answer. @Basit Siddiqi , @Linda Weygant , @Michael Plaks , @Nicholas Aiola , @Eamonn McElroy , what do my esteemed cpa colleagues say (this would be a great introduction for you also Sandy)?
As Dave referred to, there are safe harbors outlined in Rev. Proc. 2008-16 - see Section 4.02(1) (bolded for emphasis):
(1) Relinquished property. A dwelling unit that a taxpayer intends to be relinquished property in a § 1031 exchange qualifies as property held for productive use in a trade or business or for investment if:
(a) The dwelling unit is owned by the taxpayer for at least 24 months immediately before the exchange (the “qualifying use period”); and
(b) Within the qualifying use period, in each of the two 12-month periods immediately preceding the exchange,
(i) The taxpayer rents the dwelling unit to another person or persons at a fair rental for 14 days or more, and
(ii) The period of the taxpayer’s personal use of the dwelling unit does not exceed the greater of 14 days or 10 percent of the number of days during the 12-month period that the dwelling unit is rented at a fair rental. For this purpose, the first 12-month period immediately preceding the exchange ends on the day before the exchange takes place (and begins 12 months prior to that day) and the second 12-month period ends on the day before the first 12-month period
begins (and begins 12 months prior to that day).
It is also important to note the paragraph just before - Section 4.01 (bolded for emphasis):
.01 In general. The Service will not challenge whether a dwelling unit as defined in section 3.02 of this revenue procedure qualifies under § 1031 as property held for productive use in a trade or business or for investment if the qualifying use standards in section 4.02 of this revenue procedure are met for the dwelling unit.
It's important to keep in mind that "personal use" also includes family, friends, or anyone else who did not pay FMV rent to stay there; if they paid FMV rent, their stay(s) would not be considered personal use.
Wow, thank you both so much. @Dave Foster thank you for the responses and referrals, and I look forward to talking with you next week. @Nicholas Aiola , thank you for that very detailed (bolded appreciated) answer. This was super helpful, and I feel I can rest assured my property will qualify for a 1031 exchange. Yay!
@Sandy Metivier there is a good chance you do not meet the threshold for this to be considered a rental property. You mention it is rented the majority of the time, but the threshold is not majority. It is a two part test:
1. Less than 14 days personal use - you wouldn't meet this based on what you said.
2. Less then 10% personal use - if you lived there over a summer, it is impossible to meet this. There are 365 days in a year, so you could theoretically live in it 36 days maximum. AirBNB statements list exactly how many days and what days it was rented. If you are forced into a situation where you need to defend yourself, it is likely to raise questions when nobody rented it for an entire summer.
I am sure plenty of people lie about personal use amount, but just be aware there is a paper trail showing when it was actually rented.
Have you been claiming depreciation on the property? I am just wondering if the gain and depreciation recapture combined is big enough to warrant a 1031.
@Joe Splitrock Good points for @Sandy Metivier . But there are two different threshholds here. There is the safe harbor that requires two consecutive years rental, no more than 14 days personal use or 10% of the number of days actually rented (not counting days you stay in it working on it).
This safe harbor serves two bench marks:
1. Within this threshhold you may depreciate the property and take income against expenses.
2. The IRS guarantees your description of this as investment property.
What this does not mean is that you must meet this standard in order to have an investment property. So it is very plausible that a property could be held for investment purposes and yet no qualify to take depreciation. It does raise the bar a little to demonstrate your investment intent. But the two are not mutually exclusive.