When discussing the concept of 1031 Exchanges, we often get questions about which properties qualify for an exchange. People specifically question whether they can exchange their primary residence or a vacation residence for another under a 1031 exchange. The IRS has clear rules on what does and does not qualify for a 1031 exchange, so to answer the question of if a non-investment property can qualify, we must dig a little deeper.
Three Types of Properties
According to the IRS, there are three types of properties individuals can own. These three properties are:
- Primary Residence
- Second or Vacation Home
- Investment Property
Typically, a 1031 has to involve an investment property. If you are looking to perform a 1031 exchange, you must purchase like-kind real estate. In other words, you must purchase the same type of property you sell, which is this case should be an investment property.
With very small exceptions, primary residences do not count towards a 1031 exchange. Primary residences are defined by an owner having owned and used the property for the last two years OR two years (twenty-four months) out of the last five years.
The IRS can establish residence of the owner by a number of ways. These usually include utility bills, tax returns, W2 forms, and more. If there is any concern about your property being a primary residence, the IRS can determine whether or not that is the case.
There are small exceptions to this rule, but they tend to be tricky and should be approved by a company or individual who has extensive experience dealing with 1031 exchanges to avoid any issues.
Second Homes or Vacation Homes
Vacation properties are a slightly different story than primary residences. Because people often rent out their vacation homes while the owner is not using them, they can qualify as a type of investment property and thus be eligible for a 1031 exchange.
However, not every vacation home will qualify for a 1031 exchange. There are certain requirements that must be met, otherwise the home will be treated as a secondary primary residence.
For a vacation or second home to qualify for a 1031 exchange, the following requirements must be met:
- The property must be rented out for two weeks minimum per year or 10% of the year rented (whichever is greater) AND
- The owner cannot use the property for more than two weeks per year
If these requirements are met, then a vacation or second home can be used in a 1031 exchange as long as the property it is being exchanged for is a like-kind property intended for the same use.
If the vacation home is exchanged for another vacation home, but the new vacation home will not be rented out at least two weeks of the year, then it is not like-kind. If the intent is to rent the home out in a similar fashion as the initial vacation home, then the properties are like-kind and a 1031 exchange can be performed.
As you can see, the rules and regulations regarding 1031 exchanges can be extensive. We always recommend contacting a professional if you have any questions on if your properties will qualify for a 1031 exchange.