one defer capital gain taxes on the sale of a vacation home?
Yes, quite possibly. It now (2007)
seems dependent on your intent at the time of sale. Proactive
planning can help position your property and transaction better for a
future tax-deferred exchange structure.
To exchange a vacation
home for other real estate, the crucial question to ask is:
At the date of the
exchange, is the vacation home primarily for personal use, or is it
being held primarily for investment purposes (i.e. for future
appreciation or for rental purposes)?
1031 Exchanges of Vacation Properties: Do
They Really Qualify?
of a vacation property or second home ("relinquished property") and into
a qualifying investment property or another vacation property
("like-kind replacement property") on a tax-deferred basis using a 1031
exchange was thought by some to be possible based on a Private Letter
1981-03117) issued by the Internal Revenue Service in 1981.
However, there was
extensive disagreement among professional tax and legal advisors and
1031 exchange Qualified Intermediaries as to whether real property held
and used for personal use and enjoyment such as vacation properties or
second homes could be exchanged for other qualifying investment
properties on a tax-deferred basis pursuant to
Section 1031 of the Internal Revenue Code.
Exeter's Long Standing Position
It has always been our
position that 1031 exchanges of properties intended to be held solely
for personal use and enjoyment would not qualify as property held for
investment, and that any 1031 exchange of these vacation properties
would be disqualified under audit.
The income tax issue in
question centers around whether the vacation properties or second homes
can be characterized as qualified use properties that have been held,
reported and treated as qualified investment properties or whether the
properties have merely been held and used for personal use and enjoyment
and therefore would not qualify for tax-deferred exchange treatment.
Private Letter Ruling 198103117 (PLR 1981-03117)
was issued by the Internal Revenue Service in 1981. PLRs that are more
than 20 years old should be reviewed and analyzed carefully to determine
whether they are still relevant and/or whether the Internal Revenue
Service has issued any subsequent rulings that are contrary to the IRS's
original position in the PLR.
This PLR was also
issued well before the final
Deferred Exchange Regulations were issued in 1991, and the Deferred
Exchange Regulations are very specific about exchanging qualified
investment property for like-kind qualified investment property.
Prior to the recent Tax
Court Memorandum we had to wonder whether the position contained within
the PLR was still relevant and valid or whether the IRS's position had
changed with the issuance of the final Deferred Exchange Regulations.
In addition, you should
be aware that Private Letter Rulings are requested by and therefore
issued only to specific individual taxpayers, and the PLR therefore can
only be relied upon by the specific taxpayer that it was issued to. The
rest of us can use the PLRs for guidance but can not rely upon any
specific PLR as precedent.
New Tax Court
appeared that the 1981 PLR would permit the exchange of vacation
properties held for personal use and enjoyment if the vacation property
was also held for investment. However, the Deferred Exchange
Regulations issued in 1991, approximately ten years after the PLR,
seemed to contradict the position held in the PLR. There was no other
guidance available from the IRS to help clarify this issue; until now.
Tax Court Memorandum
2007-134) was filed May 30, 2007, which provided an opinion on
whether an exchange of vacation property held for personal use and
enjoyment would qualify for tax-deferred exchange treatment. The TCM
holds that this particular 1031 exchange did not qualify for 1031
exchange treatment because the taxpayer's real intent was to acquire,
hold and use the property for personal use and enjoyment and not for
Analysis of Tax Court Memorandum 2007-134
We now know based on Tax Court Memorandum 2007-134 that the primary
intent of the taxpayer is what determines whether a property was held
for personal use and enjoyment or whether it was held for investment
purposes regardless of whether a secondary intent was present.
It also appears that your intent at the time of the disposition (sale)
of your real property is the key issue in determining whether your
intent was to hold for personal use and enjoyment or for investment and
your original intent at the time that you originally acquired your real
property is not relevent. E.g., Bolker v. Commissioner, 81 T.C.
782, 804 (1983), affd. 760 F.2d 1039 (9th Cir. 1985)
Property acquired with
the intent to hold, use and treat as vacation property (personal use and
enjoyment) will therefore not qualify for tax-deferred exchange
treatment even if a secondary intent to hold for investment exists.
The issuance of the Tax
Court Memorandum has helped clarify the issue of exchanging vacation
properties held for personal use and enjoyment, but the TC Memo does
still leave some questions unanswered.
would appear that you could change your intent from holding for personal
use and enjoyment to holding for investment purposes in order to
complete a 1031 exchange. You would most likely want to hold the
property for investment purposes for at least 12 to 18 months in order
to demonstrate that you did in fact have the intent to hold for
investment in order to qualify for tax-deferred exchange treatment at
the time of disposition (sale).
You must carefully
analyze and evaluate each of your transactions on a case-by-case basis
with your legal and tax advisors to determine if your specific fact
pattern would support a position that your vacation property or second
home was in fact held for investment and would therefore qualify for
tax-deferred exchange treatment.
Certainly, the more
rental, investment or business use activity the stronger your argument
will be that you had the intent to hold for investment. The more proof
you have that the property was held, treated and reported as investment
property, the better your position will be for a tax-deferred exchange.
The more personal use, the weaker your argument. Proactive planning can
help position your property and transaction better for a future
tax-deferred exchange structure as well.
END OF ARTICLE