A real estate property like a vacation home can and does produce significant tax consequences. When selling an asset of this kind at a price higher than its tax basis, you make a gain. Since your profits on the sale of the vacation home are high, you have capital gains tax obligation. This means that you will not get to enjoy the money you make. However, there is a clever way to avoid such consequences. You can defer capital gains tax by doing an IRS 1031 exchange. A 1031 exchange refers to trading a business or an investment without tax. There is no doubt that vacation homes qualify for this type of swipe.
How the IRS Policy Applies To Vacation Homes
The Internal Revenue Service says that vacation homes are eligible for a 1031 tax-deferred exchange. As long as the vacation home is used for rental purposes, it can be used to defer capital gains tax. Attention should be paid to the fact that if you hold half the property for personal use, only half of it can be used to reap tax benefits. If you use the entire vacation house for personal use, you have no chance whatsoever to complete a Section 1031 exchange.
To be eligible for the swap, you have to hold the real estate asset for at least 24 months prior to the exchange. What is more, you must have rented the property to another person for at least 2 weeks. Concerning the replacement property, you must keep it in your possession for at least 24 months after the trade. Yet again, you are required to rent out the real estate for at least 2 weeks at market rates.
What If The Property Is Used For Personal Use And Investment Purposes?
If you are using the vacation home for personal use and for investment purposes, your situation is more complicated. Whether or not you can complete an IRS 1031 exchange depends on how you are currently using the real estate asset. More precisely, it revolves around how much you use the vacation home for personal use. Using the property for personal use but to a limited extend may not necessarily disqualify your transaction. But taking into account the fact that incidental personal use is not clearly defined in the Internal Revenue Code, there is no way of knowing what the outcome may be. If you find yourself in a situation of this kind, get help from an expert.
Transforming a Vacation Home into an Investment Property
You can prepare in advance for the section 1031 exchange. To avoid unpleasant consequences, convert the vacation home into an investment property. What do you have to do? All you have to do is rent the property to another person at a fair price. Unquestionably, there are other measures you can take. Hire a property manager and keep the use of the vacation home to a minimum. If you do this, you will be able to enjoy the tax benefits offered by the IRS.